Public Bill Committee

[Mr. Eric Illsley in the Chair]
(Except clauses 1, 3, 7, 8, 12, 20, 21, 25, 67 and 81 to 84, schedules 1, 18, 22 and 23, and new clauses relating to microgeneration)

Schedule 9

Insurance companies: transfers etc

Question proposed [this day], That this schedule, as amended, be the Ninth schedule to the Bill.

Question again proposed.

The Economic Secretary to the Treasury (Ed Balls):  Thank you, Mr. Illsley. I am pleased to welcome you back after our morning’s activities. We were discussing schedule 9 and I had explained in extensive detail our approach to the schedule and our targeted anti-avoidance rule. I was talking about the schedule in the context of the extensive consultations that have been going on over the last year on insurance tax matters.
I was explaining at the end of our last sitting that there is a power in the schedule to amend legislation for the start date of the TAAR by regulation, which is a different approach because despite much hard work, neither the Government nor the industry are yet fully satisfied that the legislation will work exactly as we intend, as a number of details remain to be sorted out. The pre-Budget report envisaged that most of the legislation would operate from 1 November 2007, allowing several months between finalisation of the rules and the start date.
However, because more time is needed for this schedule, commencement is now to be determined by an appointed day order, which gives flexibility to allow for several months between finalisation and its coming into effect, whenever the form of the legislation is finalised. Changes to the legislation that are needed to finalise it can be made by regulations, using the power in schedule 9, which means that we do not have to wait until the next Finance Bill or rush to get the final details right on Report. The regulations will be introduced using the affirmative resolution procedure to ensure that there is an opportunity for proper scrutiny in due course.
The legislation, as amended by any regulations, will come into effect from a day to be appointed, which will depend on further consultations, but which we would not expect to be before spring next year. However, we are confident that with further consultation we will be able to get the final details of the schedule sorted out. I commend the proposal to the Committee.

Mark Hoban: I welcome you to the Chair, Mr. Illsley.
I want to ask the Minister about the targeted anti-avoidance regime to which he referred before the lunch break. As I understand it, the supplementary avoidance rule contains a motive test and a pre-clearance test. I was surprised and taken aback when I saw that there was a pre-clearance test, because I remember the Minister lecturing me quite firmly in connection with clause 27, saying that there was no need for such a test. He said:
“The amendments are unnecessary because the clause contains a main purpose test, which means that it will apply only when a person has entered into arrangements that have the main purpose of securing a tax advantage, which is to say tax avoidance. Such schemes do not happen by accident. They are the result of contrived circumstances in which transactions are undertaken or carried out primarily to achieve a desired tax effect, as opposed to a genuine economic purpose”.
He continued:
“That main purpose may be inferred from the actions of the parties to the arrangements, but it is best understood by the person making the arrangements. It is therefore not necessary to set up a clearance regime when the person best placed to judge whether the rule applies is the person who makes a clearance application.”—[Official Report, Public Bill Committee Finance Bill, 17 May 2007; c. 223.]
It appears that there is one rule for clause 27 and one rule for schedule 9. Having re-read the Minister’s explanation in our debate on Tuesday morning, I am not clear why a clearance rule is right in schedule 9 but was not appropriate for clause 27.

Rob Marris: Bearing it in mind that the Committee is scrutinising the wording of the proposal, among other things, I want to raise a rather more prosaic matter, and my hon. Friend the Economic Secretary may wish to write to me about what appears to be the most curious piece of drafting in the Bill, on pages 156 and 157. Paragraph (10)(2) substitutes part of a sentence, the final words of which are
“or as a business transfer-out,”.
The Bill continues:
“(3) In that sentence (as amended by sub-paragraph (2))—omit “or as a business transfer out”.
If I am reading that correctly—I might not be—sub-paragraph (2) inserts some words and sub-paragraph (3)(a) immediately removes some of them. That seems very curious to me. Perhaps my hon. Friend could write to me about it later.

Edward Balls: I am very grateful for my hon. Friend’s commentary. The claim, “This is the most curious piece of drafting I have ever seen in a Finance Bill” is, for him, one hell of a claim. Whether it would stand the test of true scrutiny I do not know. He has a fine track record of highlighting curious pieces of drafting. I can only encourage him to participate fully, not only in the next stage of our consultation but in the affirmative procedure that we will apply to ensure that that drafting is fully reflected in the final schedule. If I can shine any light on this particular curiosity I shall be happy to write to my hon. Friend. I shall ensure that all members of the Committee are copied and that the letter is worth framing.
I am grateful to the hon. Member for Fareham for having highlighted the fact that we on this side of the Committee do not take an over-dogmatic or idealistic approach to these matters but are happy to proceed case by case on the basis of the consultation and the evidence that arises in any particular circumstance. Before Conservative Members get over-excited, it would be foolish and wrong of me to lecture them, as Conservatives, on the importance of precedent. That is clearly an important part of conservatism, whatever—I will not go there. I fear that the issue of grammar schools might be ruled out of order, Mr. Illsley.
Clearance procedures for transfer of business are in place under existing legislation. We are replacing previous clearance procedures with a new and more streamlined one. Unlike the discussion on the previous clause, this is not a debate about whether to introduce a new clearance procedure. Perhaps because of the complexity of the tax regime legislation, clearance is judged to be desirable in this case from a Financial Services Authority and court point of view. It was desirable before and it will be in future. I hope that the hon. Gentleman finds that to be an accurate, non-ideological and conservative answer to his question.

Question put and agreed to.

Schedule 9, as amended, agreed to.

Clause 40 ordered to stand part of the Bill.

Schedule 10

Insurance companies: miscellaneous

Edward Balls: I beg to move amendment No. 90, page 159, line 22, leave out from beginning to end of line 10 on page 163 and insert—

‘Contingent loans

1 In section 83ZA(4) of FA 1989 (contingent loans), for “the end of the” substitute “any time during a”.’.

Eric Illsley: With this it will be convenient to discuss Government amendments Nos. 92 and 94 to 96.

Edward Balls: I shall try to be brief, but at the same time to provide a bit of context for the amendments in order to satisfy Members on both sides of the Committee, who will be interested to know the detail of the schedule.
The schedule contains a range of measures to clarify and simplify miscellaneous life assurance tax provisions, most of which arise from the life assurance tax rules consultation process. I shall discuss the first of them, covered by paragraphs 1 and 2, when I highlight the amendments. The other important measure in schedule 10, packaged in paragraph 3, is a reform of the treatment of so-called structural assets held by a life insurance company in its long-term insurance fund. Structural assets are held by an insurance company as part of its trading structure, as opposed to assets that are expected to be turned over in the course of its trade. A major example, and one included in the Bill, is shares in subsidiary companies that themselves are insurance companies.
However, where structural assets are held in a company’s long-term insurance fund, inappropriate tax rules can arise, because the life insurance tax rules assume that all assets held in a long-term fund are held or sold in the course of the company’s insurance business. For example, dividends from insurance subsidiaries through structural assets are subject to corporation tax, whereas dividends from structural subsidiaries of other types of trading company are exempt.
As taxation of life insurance companies is based on their regulatory returns, it follows that write-downs can result in a tax deduction where there is no economic loss. Following consultation with the life insurance industry, we have introduced paragraph 3, which will reform the taxation of structural assets, treating them as capital assets rather than trading assets. Dividends from structural assets will be exempt from tax, giving the insurance industry parity with other traders.
A further measure in paragraph 4 will remove the restriction on use of capital losses where a life insurance company sells holdings in an authorised unit trust or an open-ended investment company to the manager of that trust or company, and that manager is a member of the same group of companies as the life insurer. The capital gains rules impose restrictions on the use of capital losses on all disposals between connected parties, such as members of the same group. The policy reason is that connected parties have opportunities to manipulate the circumstances of the disposal that are not available to independent parties.
However, where a life insurer disposes of holdings in unit trusts or open-ended investment companies, both Financial Services Authority rules and life insurance tax rules ensure that the disposal is at market value and minimise opportunities for manipulation, regardless of who acquires the assets. For that reason, the life insurance industry has argued that it is unfair to restrict any losses arising. The Government accept its argument, and schedule 10 will remove the restrictions. 
The remainder of the schedule comprises a general tidying up of life insurance tax rules, modernising definitions, removing duplication by putting all definitions in one place and repealing spent or obsolete provisions. I look forward to the scrutiny of my hon. Friend the Member for Wolverhampton, South-West and to seeing whether obsolescence and obscurity have been fully tackled.
The amendments will modify the new provisions in response to our consultation. Paragraph 3 will reform the taxation of structural assets, treating them as capital assets rather than trading assets. Dividends from structural assets will now be exempt from tax, giving the insurance industry parity. The schedule defines structural assets initially as shares in and loans to subsidiaries of insurance companies that themselves write insurance business. The measure also includes a regulatory power to add to or amend the list of structural assets; however, the life insurance industry will be consulted before that power is exercised.
A short time ago, the Association of British Insurers and other parties sent a number of representations to Her Majesty’s Revenue and Customs about the new measures. At the time, it was thought that the schedule would be debated last week, so HMRC was able to deal immediately with only two straightforward points, which are covered by Government amendments Nos. 91 and 92. But when debate on the schedule was deferred to today, I agreed that further amendments—Government amendments Nos. 130 to 133—should be tabled now, rather than on Report, to give effect to many of the ABI’s requests for clarification and relaxation.

Mark Hoban: On a point of order, Mr. Illsley. I am slightly confused as to whether there are two groups of amendments to schedule 10 or one. There seems to be some interrelationship between the two. I am not sure whether we are debating one group or two separate groups.

Eric Illsley: There are two groups—Government amendments Nos. 90, 92 and 94 to 96, and Government amendments Nos. 130 to 133, and 91 and 93. I assumed that the Economic Secretary was referring to a group of 10 amendments, that he was not moving amendment No. 130, which will be in the following group, and that he was simply referring to the fact that they all apply to schedule 10. However, there will be separate debates on both groups.

Edward Balls: I apologise to the hon. Member for Fareham: I did not read fully and correctly the punctuation of the schedule before us. It seemed to me that, to understand these amendments, it was important to put them in the context of the schedule. With your permission, Mr. Illsley, I should like to frame all the amendments together, accepting your right not only to determine that we should vote on separate groups but to allow a second debate on the second group, if you prefer. It seems that the amendments are all of a piece, as they emerged from a detailed set of consultations that I have been able to update in recent days. There was not a principal distinction between the two groups, but I am happy to take your guidance, Mr. Illsley.

Eric Illsley: I will be guided by the wish of the Committee. If it has no objection to taking both groups together, I have no objection. If hon. Members have no objection, we can proceed on that basis, in which case with Government amendment No. 90 it will be convenient to take Government amendments Nos. 92, 94 to 96, 130 to 133, 91 and 93.

Edward Balls: This is not about a difference of scope or subject. Because we have had more time, we have been able to add further amendments in recent days at the request of the ABI, particularly Government amendments Nos. 131 to 133. We have tried to add those amendments to meet the needs of the industry. There is one case where we have changed the legislation to ensure that a company cannot generate a loss earlier than it would do so naturally by moving the asset around the company or its group.
That is not fully to the liking of the industry, but it was necessary to ensure that we protected the Exchequer. However, I have asked HMRC to monitor that rule carefully to ensure that it works properly, and not harshly. I also know that the industry does not like the way in which section 83XA(6) deals with the capital gains treatment of structural assets. That is not something that we have been able fully to bottom in the consultation. The ABI’s preferred solution seemed to skew the results too far towards an Exchequer loss, and both sides accept that that may be a theoretical, rather than a substantial, point of difference. However, it is an area where we are trying to do the right thing, while protecting the revenue base. I am happy to give an assurance to both the ABI and Opposition Members that we will keep that under review. The amendments ensure that the structural assets are given in all cases, including where the substantial shareholding exemption is relevant, and where there is a transfer of business. I am happy to commend the amendments to the schedule to the Committee.

Mark Hoban: I thank the Minister for his explanation of the amendments, and of paragraph (3) on structural assets, which is a difficult part of the legislation, as it affects life assurance companies. Many such companies hold many structural assets in their funds, which are available for use in certain circumstances to meet the policy holders’ liabilities. There are some quite difficult interactions with FSA rules and tax rules about the valuation.
I should like to raise three areas with the Minister in connection with those rules. The first is the treatment of gains, which he has already touched on, but I want to come back to it in a little more depth in a minute. As I understand it, paragraph (3) excludes the movement in value on insurance dependants from tax, so ending the double taxation of insurance subsidiaries. Certainly in the past, although I am not sure that it is the case now, life funds have held other trading businesses within their funds. A distinction has been between those involved in insurance business and those involved in non-insurance business. I should like to understand why it is only insurance dependants that have been excluded from tax.
The second point concerns interest. Movements in value on loans for insurance subsidiaries will not be taxed and nor will the interest on those loans. However, my understanding is that the interest deductions on the other side of the loan transaction will be relievable against tax credit. If the interest payable is subject to relief, why is the interest receivable not going to be taxed? Does the Minister think it appropriate for debts and loans to be included in our structural assets? There is a slight risk that an asymmetrical treatment will arise where life assurance companies engage in tax planning, recognising the difference in treatment on the interest payable on loans.
The third point goes back to the central issue of the treatment of gains, on which there is most debate between the Treasury and the ABI. Taxation is charged when a qualifying asset leaves the long-term fund of the life assurance company. That is determined by taking the difference between the historic cost of the asset and its admissible value at the relevant time, which is 1 January 2007 for existing assets, and the time that the non-profit fund of the life assurer acquired the assets, for assets acquired after that date.
The ABI believes that such gains should be taxed as capital gains and therefore should attract indexation to give them the same tax treatment as other companies. There should also be an opportunity to compute such gains using either the higher of the original base costs or, where relevant, the market value at March 1982. Again, that is the same treatment that is available to other businesses. It is a consistency point between assets held by life assurance companies and assets held by other companies. Will the Economic Secretary give us some background on the reason why there is a difference in treatment? Certainly, other businesses go through the process of being able to have indexation gains and looking at the base cost of the 1982 market value cost where that is appropriate. There seems to be a mismatch between general business taxation and the taxation of life assurance companies. Some issues of shareholder capital losses also float through. It is not a particularly straightforward piece of legislation which is why, despite the consultation that has been taking place since June last year, we are still making changes as we approach the end of May. The Government are still proposing changes, with the tantalising prospect of further amendments to come. I should be grateful for some clarification on those points.

Rob Marris: This is the last time that I will raise this matter, but I do so because I am getting sick of it. Amendment No. 93 starts with the word, “But”. It is not only ungrammatical but completely redundant. I have been making the point throughout the Bill that I hope at least in next year’s Finance Bill we can have some decent and grammatical wording and not include redundant words.

David Gauke: This morning, the Economic Secretary waxed lyrical about the consultation process. He stressed its importance and the openness and trust that has built up between the industry and the Government. Indeed, he was very open and honest about some of the difficulties that arose in the autumn of 2005, which he put down in part to a lack of consultation. Why, therefore, does the ABI state in its briefing to members of the Committee:
“HMRC have tabled last minute amendments, which have not been subject to the consultation process and we are concerned at the late changes to legislation that had previously been discussed at length”?

Edward Balls: Let me answer those questions as briefly as I can. On the subject of the word, “But”, we shall reflect and try to draw wider lessons as part of the Finance Bill process about the excessive use of that word at the beginning of sentences. The hon. Member for Fareham made three points. The first concerned the definition of structural assets and insurance dependants. Insurance dependants are by far the most significant set of assets, which is why the provision provides for them expressly. However, the schedule includes the power to add other assets by means of regulation. Discussion will continue, and if other assets need to be added to the same category, that will be possible.
There is a misapprehension on the second point; interest receivable will be taxed, so there is no asymmetry. On the third point, I refer the hon. Gentleman to the industry views that I quoted in my introduction to this part of the Bill. Ernst and Young’s Budget website said:
“A key lesson from the life tax consultation is the efficiency of the working group approach. The use of the working group as the primary means of progressing issues of both broad policy and fine detail is now deeply embedded as a feature of the regular working relationship between HMRC, industry and advisors.”
That constitutes substantial progress from where we were 18 months ago, so although I do not hesitate to say that improvement was clearly needed, I hope that that has been delivered.
There were late representations from the ABI and others in relation to the new provision—I do not use the word “late” in a value-loaded way, I mean merely that the issues arose late in the consultation. We could easily have decided to postpone any attempt to sort those issues out, but we decided that we could deal with Government amendments Nos. 91 and 92 consensually, when more time was available. The ABI requested clarification and indeed relaxation, and our judgment in relation to Government amendments Nos. 130, and 131 to 133, was that clarification was the right course, even if we could not deliver the degree of relaxation that the ABI wanted. I know that it is disappointing that we cannot go as far as the industry would like, but we judged that maximum clarity at this stage would be the better choice.
As I have said, the issues are very complicated—even more so than some of those that we have already debated in connection with the relevant clauses. We do not know how much the problem is theoretical rather than real, and the best commitment that I can give to the ABI and to the Committee is that we shall closely monitor the operation of the system. If it works heavy-handedly or if there are indeed problems in relation to capital gains treatment, we shall revisit the legislation. I have already expressed my willingness to table further amendments or regulations before next year if necessary.

Mark Hoban: I was not sure whether the Minister was about to conclude, so may I prompt him to deal with my point about the different treatment of gains on structural assets. Structural assets held by a non-life insurance company will be subject to a different capital gains tax regime from that which will apply to structural assets held within life assurance funds. I should like to understand the reason for the difference.

Edward Balls: I believe that I already answered that when I referred to the discussions on differential treatment in section 83XA(6), which deals with the capital gains treatment of structural assets. It is a complex issue, which we are still trying fully to understand, and the best that I can do is repeat that discussions with the ABI will continue in the coming weeks. If I can give more detail to the hon. Gentleman after that, and after further expert consultation, I shall be happy to write him a letter. Pre-empting that would be foolish, however.

Mark Hoban: I am grateful for the Economic Secretary’s offer, but I would quite like to know now why there is a difference rather than hear about how the problem might be resolved.

Edward Balls: With your permission, Mr. Illsley, to avoid further detaining the Committee by attempting a detailed, complex definition, I shall write to the hon. Gentleman, which will enable him better to understand the ongoing consultations.

Amendment agreed to.

Amendments made: No. 130, in schedule 10, page 163, line 16, leave out
‘by an insurance company held in a non-profit fund’
and insert
‘held by an insurance company in a non-profit fund.
(1A) For the purposes of subsection (1) above—
(a) an increase in the value of structural assets includes any amount by which their fair value when they cease to be structural assets, or come to be held otherwise than in any of the company’s non-profit funds, exceeds their admissible value at the end of the preceding period of account, and
(b) a decrease in the value of structural assets includes any amount by which the admissible value of the assets at the end of the period of account in which they become structural assets, or come to be held in any of the company’s non-profit funds, is less than their historic cost.’.
No. 131, in schedule 10, page 163, line 29, after ‘be’ insert
‘a structural asset or comes to be held otherwise than in any of the company’s non-profit funds and, immediately before it came to be a structural asset held in any of the company’s non-profit funds it (or any part of it) was’.
No. 132, in schedule 10, page 163, line 34, leave out from ‘the’ to end of line 46 and insert
‘relevant period of account.
(4A) For the purposes of subsection (4) above “the relevant value difference”, in relation to an asset, is— H C — A V
where—
HC is its historic cost, and
AV is its admissible value at the relevant time.
(4B) In subsection (4) above “the relevant period of account” means—
(a) in a case within paragraph (a) of that subsection, the period of account in which the asset ceases to be a structural asset or comes to be held otherwise than in any of the company’s non-profit funds, and
(b) in a case within paragraph (b) of that subsection, the period of account in which the asset first comes to be held otherwise than by the company or (where the company is a member of a group) otherwise than by a company which is a member of the group;
and section 170 of the Taxation of Chargeable Gains Act 1992 (meaning of “group” etc) has effect for the interpretation of this subsection.
(4C) In this section “historic cost”, in relation to an asset which is or has been held in any of the company’s non-profit funds, means—
(a) where the asset came to be held in any of the company’s non-profit funds on acquisition from another person, the consideration given by the company for the acquisition of the asset, and
(b) otherwise, its fair value when it came to be held in any of the company’s non-profit funds.
(4D) In subsection (4A) above “admissible value”, in relation to an asset and a time, means the value of the asset as shown in column 1 of Form 13 of the periodical return for the period ending with that time (or as would be so shown if there were a periodical return covering a period ending with that time).
(5) In subsection (4A) above “the relevant time” means—
(a) in a case where assets become structural assets held in any of the company’s non-profit funds by virtue of the commencement of this section, 1st January 2007, and
(b) otherwise, the time when the assets become structural assets held in any of the company’s non-profit funds.’.
No. 133, in schedule 10, page 164, line 3, after ‘to’ insert ‘its’.
No. 91, in schedule 10, page 164, line 20, at end insert—
‘(4) In section 211 of TCGA 1992 (transfers of business: application of section 139 of that Act), as amended by paragraph 14 of Schedule 9 to this Act, after subsection (2) insert—
“(2A) The reference in subsection (2) above to assets included in the transfer does not include structural assets within the meaning of section 83XA of the Finance Act 1989.”
(5) In paragraph 17 of Schedule 7AC to TCGA 1992 (substantial shareholdings exemption: special rules for assets of insurance company’s long-term insurance fund), after sub-paragraph (4) insert—
“(4A) The reference in sub-paragraph (2) to an asset of the investing company’s long-term insurance fund, and the references in sub-paragraphs (3) and (4) to shares or an interest in shares held as assets of its long-term insurance fund, do not include a structural asset, or structural assets, within the meaning of section 83XA of the Finance Act 1989.”.’.
No. 92, in schedule 10, page 170, line 33, leave out ‘amendments made by paragraph 1 to 3’ and insert
‘amendment made by paragraph 1 has effect on and after 10th May 2007.
( ) The amendments made by paragraphs 3,’.
No. 93, in schedule 10, page 170, line 35, at end insert—
‘( ) But the amendment made by paragraph 3(4) does not apply where the transfer of business concerned took place before 10th May 2007.’.—[Ed Balls.]

Schedule 10 agreed to.

Clause 41 ordered to stand part of the Bill.

Schedule 11

Technical provisions made by general insurers

Edward Balls: I beg to move Government amendment No. 76, in schedule 11, page 172, line 38, leave out from first ‘the’ to ‘and’ in line 40 and insert
‘reinsurance to close amounts of the members,’.

Eric Illsley: With this it will be convenient to discuss Government amendments Nos. 77 and 78:

Edward Balls: The schedule repeals complex mechanical tax rules that were introduced in 2000 to limit any tax advantage if general insurers’ provisions to meet policyholders’ claims were greater than necessary. It provides for transition and a new set of rules that will provide a more proportionate response for the tax risk. The rules will be supplemented by regulations.
The Government amendments to the schedule arise from discussion with Lloyd’s. Government amendments Nos. 76 and 77 will substitute for “reinsurance to close contracts” the term “reinsurance to close amounts”. Reinsurance to close is a mechanism by which a Lloyd’s syndicate closes its accounts. The commercial definition of reinsurance to close has evolved over time. The amendments ensure that the tax rule reflects the definition in Lloyd’s rules and that the schedule has its intended scope.
Government amendment No. 78 is a response to the concern of Lloyd’s that the schedule could have unintended unfair results in particular circumstances. It will enable the making of regulations to deal with those circumstances, which include members leaving syndicates and members having their own reinsurance arrangements in addition to arrangements that the syndicate may have. Officials are discussing with Lloyd’s an appropriate solution to the issue, so draft regulations are not yet available to us or to the Committee. Any regulations that are passed under the new power would reduce or eliminate the effects of adjustments that would arise under the schedule. They will be discussed in detail with Lloyd’s before they are laid. I commend the amendments to the Committee.

Amendment agreed to.

Amendments made: No. 77, in schedule 11, page 173, leave out lines 1 to 6 and insert—
‘(a) the reference to reinsurance to close amounts of any member of a Lloyd’s syndicate is to any consideration which, in accordance with the rules or practice of Lloyd’s, is given (or any amount which, in accordance with those rules or practice, is treated as consideration given) by the member in respect of the liabilities arising from the member’s underwriting business in an underwriting year for the purpose of closing the accounts of the business for that year, and’.
No. 78, in schedule 11, page 173, line 19, at end insert—
‘(10A) The Commissioners for Her Majesty’s Revenue and Customs may by regulations—
(a) provide in prescribed circumstances for paragraph 1 not to apply in relation to any member of a Lloyd’s syndicate, or
(b) provide in prescribed circumstances for a reduction in relation to any member of a Lloyd’s syndicate of the amount which (as a result of that paragraph) is not to be taken into account in the calculation mentioned in sub-paragraph (2) of that paragraph.’.—[Ed Balls.]

Schedule 11, as amended, agreed to.

Clauses 42 and 43 ordered to stand part of the Bill.

Schedule 12 agreed to.

Clauses 44 and 45 ordered to stand part of the Bill.

Clause 46

Sale and repurchase of securities

Question proposed, That the clause stand part of the Bill.

Mark Hoban: I think that there is a degree of consensus around this clause, certainly from people in the industry. In its representations on the clause, the Chartered Institute of Taxation said that in the Budget press release, BN15, it was implied by paragraph 3 that existing repos would be “grandfathered”, but that is not mentioned in the Finance Bill. It is seeking confirmation that it will be included in the regulations made under subsection (3). I would be grateful if the Minister could confirm whether that is the case.

Edward Balls: Mr. Illsley, would it be helpful to introduce schedules 13 and 14 as they are mentioned under clause 46?

Eric Illsley: Again, I am in the hands of the Committee. If it is the Committee’s wish or if it would be easier to take a general debate on clause 46 and the Government amendments to schedule 13, we can do that.
With the stand part debate, it will also be convenient to take Government amendments Nos. 102 to 104 to schedule 13.

Edward Balls: Clause 46 introduces schedules 13 and 14. Schedule 13 constitutes a comprehensive new regime for the charge to corporation tax of sale and repurchase transactions entered into by companies. Those transactions are widely known as repos.
Schedule 14 contains a number of consequential amendments to other provisions of the Income and Corporation Taxes Act 1988 made necessary by the repeal of the existing provisions for taxing repos and their replacement by the rules in schedule 13.
The three Government amendments make a minor modification to schedule 13. They correct a defect that might have led to loss of tax. The new rules for charging sales and repurchase agreements to corporation tax provide that where a company sells securities under a repo, it is to be taxed on income arising on the securities as if the sale had not taken place. That is subject to the requirement that the company must recognise the income in its accounts during the period of the repo.
That requirement may result in income falling out of the charge to tax in which the borrower is taxed on a receipts basis in respect of income arising on the securities. For accounts purposes, it recognises that income before entering into the repo. In that case, it will not recognise the income again during the repo. If the amendments were not made, the income could not be charged to tax. The amendments, therefore, omit the requirement that recognition of the income for accounts purposes must take place in the same period in which the arrangement is in force. That ensures that companies remain taxable on the income, provided that that is reflected in their accounts.
The amendments allow us to move forward with schedules 13 and 14. Repos are widely used in the financial markets as a form of secured loan. They involve the sale by a person of securities—shares or debentures—under an agreement that those will subsequently be repurchased at an agreed date at a price agreed at the outset. The sale of the securities realises cash that is economically equivalent to a loan that is repaid with interest, in the form of an increased repurchase price, when the securities are bought back.
As hon. Members know, at the time of the pre-Budget report we made a formal announcement of our intention to consult on new legislation in this area. Since then, there has been detailed consultation. HMRC has sought the views of interested parties on the way forward, including on the draft legislation. The consultation has been very constructive; we believe that we have given all interested parties an opportunity to ensure that the new legislation works properly. However, if business representatives consider that there are difficulties or strong reasons why the commencement should not happen on 1 October as specified, we will consider what they say.
This is a complex area. However, given our consultation, we should be able to go for commencement on 1 October. That will give business sufficient time to prepare for the new rules and accounts and for how lenders will be taxed. As I said, this is a modernisation of the interaction of tax and accounting; it will reduce the amount of legislation devoted to repos and simplify the current rules.
The answer to the question put by the hon. Member for Fareham is yes. The details will be set out in the regulations, which will follow in due course.

Question put and agreed to.

Clause 46 ordered to stand part of the Bill.

Schedule 13

Sale and repurchase of securities

Amendments made: No. 102, in schedule 13, page 180, line 9, after ‘that’, insert ‘or any other’.
No. 103, in schedule 13, page 180, line 9, after ‘period’, insert
‘or taken into account in calculating the amounts which are so recognised’.
No. 104, in schedule 13, page 183, line 21, after ‘that’, insert ‘or any other’.—[Ed Balls.]

Schedule 13, as amended, agreed to.

Schedule 14 agreed to.

Clause 47 ordered to stand part of the Bill.

Schedule 15

Controlled foreign companies

Mark Hoban: I beg to move amendment No. 108, in schedule 15, page 196, line 5, leave out from first ‘amount’ to end of line 7 and insert
‘is created directly by genuine business activities, and which—’

Eric Illsley: With this it will be convenient to discuss the following amendments: No. 109, in schedule 15, page 196, line 11, leave out subsection (5).
No. 110, in schedule 15, page 196, line 27, leave out from ‘subsection (4)’ to end of line 33 and insert
“genuine business activities” means business activities which—
(a) are actually carried on in any EEA territory in which the controlled foreign company has a business establishment in any part of the relevant accounting period, and
(b) are actually carried on in that territory through that establishment, having regard to premises, staff, equipment and assets.’.
No. 111, in schedule 15, page 196, line 39, leave out subsection (9).

Mark Hoban: Thank you, Mr. Illsley, for that rapid canter through the provisions on insurance. Now I shall slow down the Bill’s progress—[Interruption.] Well, I shall slow it just a little, to ensure proper scrutiny of this important schedule about how the Government have chosen to effect their response to the Cadbury Schweppes judgment on controlled foreign companies.
It is worth starting with a general point about the whole interaction between our taxes and EU law; my hon. Friends will be keen for me to make it. We had a lengthy debate on the issue in last year’s Finance Bill Committee, although we do not intend to reprise that at any great length this year.
As the European Court of Justice judgment recognises, it is the sovereign right of member states to determine their policies on direct taxes. However, there are conflicts between that principle and other areas of EU policy; later, when we consider some of the changes to the rules on venture capital trusts, we shall come to another issue in which that conflict exists.
If I might summarise the European Court of Justice judgment on Cadbury Schweppes, it is that where a company was incorporated to undertake a genuine economic activity in another member state, the fact that the motivation to do so—or to use a more familiar term, one of the main purposes of so doing—is to enjoy the lower rates of tax in that territory does not mean that the company’s profits should be taxed at the higher rate applying in the UK. In particular, that issue emerges when the mainstream rate of corporation tax in the UK diverges from rates elsewhere in the EU.
The Court ruled that the profits of a business established in another European economic area state can be taxed at the UK rate only if the arrangements were wholly artificial. Let me quote from the Court judgment:
“If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a ‘letterbox’ or ‘front’ subsidiary.”
The Government have taken the Court judgment and sought to apply it to UK law; that is what schedule 15 seeks to achieve.
Indeed, when one examines the schedule and particularly the guidance that was published at the time of the pre-Budget report, one sees that the Government’s view is that the only form of legitimate economic activity in the context of CFC legislation is one that is based on labour, as it profits only from labour that can fall outside UK taxation. If the profits are generated by capital, then broadly they must be included within UK taxable profits. So a company that decides to manage its intellectual property in one member state rather than in the UK would find that its profits from that intellectual property were taxable at the UK rate.
Even the definition of what the Government consider to be labour for the purposes of the rules is tightly defined. If a UK company sets up a subsidiary in another EU state and that company outsources some of its functions, the value created by the outsourcing does not count towards genuine economic activities. It is to broaden that definition that we have tabled amendment No. 111. Furthermore, the schedule also assumes that seeking a lower tax charge is not a valid creator of economic value, which I suppose is rather odd to all those companies that have sought to leave the UK for lower tax rate jurisdictions elsewhere in the EU. Amendment No. 109 would remove the relevant subsection from the Bill.
In a way, it is odd that we have this quite narrow definition of what constitutes genuine economic activity, since it is predicated on the basis of labour. As the hon. Member for Wirral, West perceptively pointed out, the economy has changed somewhat since the second world war and we are now a more knowledge-based economy. There is much more intensive use of intellectual property and different types of assets to generate revenue, so it seems rather strange to create the distinction between profits from labour that is not outsourced, which is a good thing, and profits from outsourced labour and from the utilisation of capital and other assets, which are a bad thing.
What I have sought to do in tabling amendments Nos. 110 and 111 is broaden in two ways the range of activities that can be deemed to be genuine business activities. Amendment No. 110 would define general business activities by reference to the wording used in the Court judgment and amendment No. 111 would eliminate a rather artificial and old-fashioned distinction between staff employed by the company and other labour, in order to recognise that a large number of companies seek to outsource part of their activities as a way of maximising value.
Amendment No. 110 would also change the period from
“throughout the relevant accounting period”
to during the accounting period, to ensure that where, say, something has been set up or closed during the accounting period, its profits can be excluded from UK taxation for the purposes of this legislation.
The wording that I have chosen in amendment No. 110 comes from the ECJ judgment: it deals with an establishment having regard to premises staff, equipment and assets and also reflects the Government’s representations during the hearing. Let me quote from paragraph 66 of that judgment:
“That incorporation must correspond with an actual establishment intended to carry on genuine economic activities in the host Member State”.
It is also worth listening to the opening of the judgment. Paragraph 67 states:
“As suggested by the United Kingdom Government and the Commission at the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment.”
My amendment No. 100 reflects Government representations made at the time. It is odd that they have not sought to reflect those representations in their definition of economic activities under schedule 15.
With your permission, Mr. Illsley, I should like to make two further comments to preclude the need for a stand part debate on schedule 15. The schedule changes procedure so that a UK company has to make an application for the profits of a EEA entity to be excluded from UK tax computation. Seeking that approval increases uncertainty and could be an impediment to reasonable tax planning. Could there not be a pre-transaction clearance procedure? In the previous debate we discussed one in respect of the insurance clause. The Government are not dogmatic in their opposition to pre-clearance procedures, so perhaps they could again demonstrate their flexibility by introducing one.
The schedule contains no deadlines setting out a time by which HMRC has to grant or refuse approval. The Chartered Institute of Taxation suggested in its submission that the onus should be on the tax authorities to show that the arrangements are artificial, rather than on the company to persuade the tax authorities that they are genuine. The CIOT also thinks that the list in the appendix to the explanatory notes of the 20 items that a business must provide to HMRC to get clearance is deliberately long and unduly onerous and almost suggests that it is a disincentive for people to apply for such clearance.
I shall conclude with an extract from the CIOT’s representations, which captures part of the problem with the measure. Last year, we discussed a similar problem when considering the treatment of group relief on the Marks and Spencer case, where the Government took a fairly narrow interpretation of the ECJ judgment which I think is now subject to challenge. The CIOT is probably right in saying:
“We think the whole approach is fundamentally defective and unacceptable, even as an interim measure pending conclusion of the discussions on the reform of...taxation”.
Even given the further reforms that my hon. Friend the Member for Chipping Barnet mentioned this morning, the schedule is defective and unacceptable in the eyes of industry experts.

Julia Goldsworthy: Again, echoing the comments of the hon. Member for Fareham, I shall make observations relating to the stand part debate so that we do not need to have the same debate again.
First, in addition to the representations made by the Chartered Institute of Taxation, the Institute of Chartered Accountants in England and Wales has some serious concerns and has noted that the provisions in schedule 15 are identical to the draft schedule published at the time of the 2006 pre-Budget report in December last year. I should like the Minister to confirm whether the schedule is identical to the draft schedule, and if that is so, whether the Government took into account the serious concerns of various professional organisations.
Secondly, I am trying to understand the basis on which the decision was made to introduce the schedule as a stop-gap before more detailed, permanent formulations are introduced. I understand that a consultation is due to start in the next few weeks. However, the Institute of Chartered Accountants has stated that
“we do not believe it is appropriate to attempt to introduce UK domestic legislation, even for a short period, which is contrary to the EC Treaty as determined by the Judgment in the Cadbury Schweppes case. Aside from the uncertainty and litigation that will inevitably follow, the approach brings UK tax policy formulation into disrespect internationally, undermining efforts to ensure that the UK remains an internationally competitive location to do business.”
I should appreciate a more detailed explanation from the Minister about why it was necessary to introduce the stop-gap legislation now, rather than engage in proper consultation that would have resulted in legislation that did not provoke the number of concerns that organisations such as the Chartered Institute of Taxation and the Institute of Chartered Accountants have raised.

David Gauke: As my hon. Friend the Member for Fareham mentioned, we discussed at some length last year the consequences of ECJ judgments on corporation tax. He will be pleased to know that I do not intend to revisit that debate at any great length, other than to say that the judgments collectively have cost the Exchequer billions of pounds; they have on occasions caused complications for British business; and Parliament has not at any point consented to direct taxation being under the jurisdiction of the ECJ.
In holding that belief, as I do, I can have some sympathy with a Government who wish only grudgingly to implement ECJ judgments. However, the difficulty is that that leads to uncertainty, and the remarks that my hon. Friend the Member for Fareham and the hon. Member for Falmouth and Camborne made highlight that point. The hon. Lady referred to a consultation document on the taxation of foreign profits, which we discussed this morning. The word from the Chief Secretary was that the document would be published shortly; I do not know whether the Financial Secretary can be any more precise about that point. The document was due to be published in the spring, but we still do not have it. I do not know whether “published shortly” means later this month or next month. I understand that the Treasury is somewhat distracted by other matters, but it would be useful to know whether there has been any progress.
As the hon. Lady mentioned, and as I believe is the case, the contents of the schedule are the same as were published at the time of the pre-Budget report in 2006. Several bodies have made representations highlighting the difficulties with that situation. Since then, the ECJ has also made its judgment on the thin capitalisation legislation, in respect of which measures introduced by the House were again reviewed to check whether they were appropriate and allowable. It covers similar ground to that which we are discussing, particularly with regard to whether a national measure restricting freedom of establishment may be justified in particular circumstances. The ECJ’s judgment on 13 March was that it may be so where it specifically targets wholly artificial arrangements.
In light of that judgment, I should be grateful to know whether the Financial Secretary still considers the schedule consistent with the attitude of the ECJ to the extent that we can anticipate a future case on the matter, whether he thinks that the thin capitalisation case can give us clues about whether the schedule’s wording is appropriate and whether he has considered revising that wording as a consequence of the judgment.

John Healey: May I welcome you, Mr. Illsley, back to the Chair this afternoon, and Committee members back to the proceedings? If the amendment is pressed, I shall ask them to reject it, and I shall explain why in a moment.
I shall first deal with a couple of the points raised by the hon. Members for Falmouth and Camborne and for South-West Hertfordshire, after which I shall cover the purpose of the controlled foreign companies rules, because that will put the matter into context and help explain why the amendments tabled by the hon. Member for Fareham would not help, and in some ways, would hinder the proper operation of the rules.
The hon. Lady and the hon. Member for South-West Hertfordshire were both concerned about consultation and the timing of the proposals. We published the draft for the measure alongside the pre-Budget report for the purpose of consultation and, since then, we have been in detailed discussions with those with a direct and representative interest in the matter. Most of the comments then were about the guidance that accompanies the operation of the rules. We will be issuing revised guidance shortly to reflect those comments. We have carefully considered the points that were made and how they applied to the Bill, and it remains essentially as it was set out in the pre-Budget report. That is not because we have taken no notice of the responses that we received. We considered them carefully, and we believe that we are taking the correct approach as I shall explain.
In response to the hon. Member for Falmouth and Camborne, I want to explain that we are taking such an approach now rather than waiting for the UK court judgment for two reasons. It is important that we act as soon as possible after the judgment to be able to deal with any potential uncertainty that can remain in light of the judgment if we do not amend the rules. Moreover, it is a fact that the UK court may take some time before it reaches it own judgment, and it does not seem sensible to wait for that.
I say to the hon. Member for South-West Hertfordshire that we do not implement such rules on the CFCs grudgingly. We implement them accurately and in a way that we judge to be fully and rightly in accordance with the European Court of Justice’s judgment.

David Gauke: A similar comment could be made about the real estate investment trust relief provisions last year in the Marks and Spencer case. Since then, a court judgment held that what the Government did last year was inadequate to meet the ECJ’s judgment on Marks and Spencer. I am merely pointing out that the same thing might be about to happen.

John Healey: If a court such as the European Court of Justice makes a judgment that has ramifications for, or is relevant to, our legislation, we have to take it into account as we are doing under schedule 15. We doing so in a way that we believe is entirely in accordance with the judgment and as accurately as is necessary. We are taking such action in that spirit, not grudgingly.
I shall now deal with the rules themselves after which I shall come to the points made by the hon. Member for Fareham. They are designed to prevent groups of companies from avoiding UK tax by diverting profits artificially to low-taxed foreign subsidiaries and therefore play an important role in protecting the UK tax base. Similar rules are in place and are in common with those in many other major economies. Their use is endorsed internationally by the Organisation for Economic Co-operation and Development, which also helpfully provides established principles for international taxation.
Our rules were subject to the challenge in the Cadbury Schweppes case at the European Court of Justice. The judgment in 2006 confirmed that the CFC rules are in principle compatible with European law providing that they are not applied to profits from genuine activities undertaken in an actual business establishment located in another member state. I may keep coming back to that because it is at the heart of the principles that the European Court of Justice affirmed in its judgment.
Let me quote from the judgment. The hon. Member for Fareham did, and I do not want to miss out. It states:
“By providing for the inclusion of the profits of a CFC subject to very favourable tax regime in the tax base of the resident company, the legislation on CFCs makes it possible to thwart practices which have no purpose other than to escape the tax normally due on the profits generated by activities carried on in national territory...such legislation is therefore suitable to achieve the objective for which it was it adopted.”
The court said that the parent company must be given an opportunity to produce evidence that a controlled foreign company is established in another member state and that its activities are genuine, which, incidentally, is what our clearance process is designed to do. If that is the case, the CFC rules must not be applied to the profits of those genuine activities.
UK rules already provide a number of generous exemptions to cover genuine activity undertaken by controlled foreign companies. However, we believe that there may be circumstances at the margins where the application of the rules is not entirely clear in light of the court judgment. For that reason, we announced our intention to amend the rules in the pre-Budget report.
It is important to be clear about what the European Court of Justice did and did not do; what it did and did not define. The ECJ did not define in any detail what might constitute profits arising from genuine economic activities undertaken in a business establishment in another member state. To provide the clarification that is needed, schedule 15 first establishes a clear and more certain application procedure through which a UK company should produce the evidence to prove the extent of a CFC’s genuine economic activities in a business established in another member state. Secondly, the schedule provides clear statutory tests on what constitutes such activities and, thirdly, it states how to calculate the profits arising from them. The schedule provides that profits are those created for the group as a whole by staff working for the controlled foreign company in a business establishment that has genuine substance in another member state.
The clause and the schedule have a particularly focused role: to provide clarity about how the CFC rules will operate following the judgment. The legislation achieves that without undermining the effectiveness of the existing CFC rules in preventing as far as possible the artificial diversion of profits from the UK. If I understood the remarks of the hon. Member for Fareham correctly, he did not dispute the importance or the principle behind having the CFC rules, but he was concerned about the practice of their implementation. His amendments would increase the uncertainty of the situation and the scope for the artificial diversion of profits. I will say why in a moment.
On the particular points that the hon. Gentleman raised, when he quoted the court, he talked about wholly artificial arrangements, which was a term used in the judgment. At that level, it is not a term that can be taken literally or can be considered outside the context of the rest of the judgment, which focuses on the purpose of the freedom of the establishment and the importance of ensuring that CFC rules do not tax profits from genuine business activity. It is clear that when the judgment was read in the round, the ECJ intended a meaningful distinction between profits from genuine activities and artificial transfers of profit within the same economic group. The legislation is designed to achieve that clarification.
The hon. Gentleman also suggested that the definitions and the workings of schedule 6 somehow entirely exclude the profits from capital. That is not the case as long as they arise from genuine business activities that are carried out in another member state and not from the artificial diversion of profit to that member state. The ECJ has spoken clearly about the purpose of the freedom of establishment and about the objective factors that indicate that a business is genuinely established and undertaking a genuine activity. The draft guidance makes it clear that that implies a distinction between profits created in another member state and profits diverted within the same economic group so that they can be located artificially in a member state with a lower tax rate.
The hon. Gentleman posed two questions, one of which was: why not have pre-clearance arrangements? Such arrangements are not normally established in this sort of procedure, and I do not see any good reasons to establish them here. There are established clearance arrangements, which after all underpin the operation and the application of the CFC rules.
The hon. Gentleman also asked about the idea of a timetable, set out perhaps in statute, for HMRC to respond. HMRC operates very tightly according to performance expectations. To a large extent, particularly in cases such as this, its ability to come to judgments and assessments, which is what we are discussing, depends on the quality and the comprehensiveness of the information that it receives from taxpayers.
The amendments, as I think the hon. Member for Fareham said, attempt to broaden the scope of the exemptions and application of the CFC rules. He said that particularly in relation to amendment No. 110, but more generally as well. He seems to have attempted to frame the amendments using the type of general language used in the ECJ judgment but when the ECJ hands down a judgment, it is not writing legislation. It is our job to write legislation in a way that captures the principles that underpin the Court’s judgment and puts them in our own tax code. The reason why we are introducing clause 47 and schedule 15 is to make explicit how the rules will apply in accordance with those EU principles, so that we have a firm basis for both HMRC and taxpayers to operate and apply the rules in practice.
If the clause and schedule were amended as the hon. Gentleman proposes, they would have the opposite effect. They would leave the legislation in a state that neither dealt with the uncertainty arising from the judgment nor protected the UK tax base against the artificial diversion of profits.
Amendment No. 109 appears to be explicitly aimed at facilitating the sort of tax avoidance that we are concerned about, because it would delete the provision in the schedule that excludes a reduction or elimination of a tax liability from the scope of the new legislation. If we accepted that, we would in effect be allowing some big businesses to avoid tax by unfairly exploiting the ECJ’s decision, leaving the general taxpayer to pick up the bill. It is not in the interests of business or the Government to make the effect of the new legislation unclear and to make it potentially open to abuse. I therefore hope that the hon. Member for Fareham will not press his amendments to a vote. I ask my hon. Friends to reject them if he does.
Finally, I want to emphasise the point with which I started. The Government are not acting grudgingly to ensure that the ECJ’s judgments are given proper effect in our rules. The potential revenues are very significant. In the pre-Budget report, we identified the revenue impact of the changes that we propose in this legislation. The forecast of our tax revenues will be adjusted as a result of the changes that we are making—from this year by £100 million and next year £175 million, and by 2009-10 we are talking about a reduction in the forecast tax revenues through the changes that we propose of £0.25 billion. The sums potentially at stake are very significant. Therefore, the onus on us is great to get the legislation right in a way that gives effect to the principles of the ECJ judgment but protects properly the UK tax base by preventing the artificial location of profits.
The amendments do not focus on genuine business activities. If they were made, groups would be able to set up tax avoidance schemes within the new rules. They would undermine our controlled foreign companies rules and would put the public purse at substantial risk. They would also put the measures at odds with aspects of the ECJ judgment. The proposed changes would increase, not decrease, uncertainty for business and HMRC in operating the rules.

Mark Hoban: I thank the Minister for his thorough and well-reasoned response to the amendments and for his justification of the Government’s activities. My hon. Friend the Member for South-West Hertfordshire hit the nail on the head when he went back to last year’s debate on the Marks and Spencer case. The way in which the Government have sought to interpret and implement that judgment through schedule 15 leaves them open to challenge. People out there will push back and challenge the rules, and they may well prove to be right, in which case the Government will have to reconsider the matter.
It is difficult to strike a balance between what is a genuine business activity and what is wholly fictitious, to use the language in the judgment. In considering that point, I looked at the draft guidance that was published at the time of the pre-Budget report. Diverting profits to a controlled foreign company using intra-group loans is given as an example that would involve some deliberate tax avoidance through the structuring of the transaction. I found the next example, about relocating intellectual property in another European economic area member state, less clear. It could be managed there, rights could be sold and value could be generated, and the guidance says that there could be some profit related to the administration of those activities. That example illustrates the difficulty of putting the judgment into practice, because I should have thought, from my reading of the judgment, that a business could reposition a property in an EEA state and have all those profits chargeable at the lower rate, rather than simply the return on the administration costs.
Part of the problem with future interpretations will lie with whether the Government have complied with the ECJ judgment. This afternoon’s debate is partly intended to probe the Government’s thinking; I suspect that the place where the measures will really be scrutinised and tested is not here, in this Committee Room, but in court. We might well come back to this topic next year, just as we have been referred back, this year, to what happened in the Marks and Spencer case. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 15 agreed to.

Clause 48

Vaccine research relief: amount of deduction for SMEs

Question proposed, that the clause stand part of the Bill.

Adam Afriyie: I shall not speak for long. I simply want to make two, related, observations on this clause and the next about the vaccine research and development credit, or tax relief, which is designed to encourage investment in research on vaccines. The clause is welcome, because it corrects a loophole, and neither I nor, I am sure, hon. Members on either side of the Committee, object to its overall thrust.
My main observation is that we in the United Kingdom have a currency called sterling that is familiar to everyone. Everything that we do in our everyday lives is denominated by it: company accounts are denominated in sterling, and it is clear and overt. For small and medium-sized businesses, accountants and everyone else, turnover is clear and they can predict pretty well what their turnover and profit will be. Consequently, they are able to ascertain whether they qualify for certain reliefs and what size of business they are classified as.
Exchange rates fluctuate and are uncertain, however. At times over the past five to 10 years, we have seen sterling move quite dramatically against the dollar and the euro, so businesses might be caught unawares. As I said, I do not object to the clause in principle, but businesses might not know into which category they fall. A business might be working on the basis that it falls within the small or medium-sized category, which might be clear from the staffing levels. However, it might not be clear whether that business falls into that category in terms of either its balance sheet value, which does not necessarily move dramatically during the year—although the exchange rate might fluctuate—or its turnover, which would enable it to qualify for the credits under clauses 48 and 49.
Throughout the Bill, pretty much everything is denominated in sterling. Duties, corporation tax, grants, credits, the reliefs for investment in the music industry and a lot of the capital and asset transfers—they are all denominated in sterling. Therefore, why is uncertainty being created in clause 48? I am sure that the Minister can tidy the issue up fairly quickly. Is the answer that we are subject to EU regulations? If so, which EU regulations tie the Minister’s hands in that regard? Why are we denominating turnover and balance sheet value in sterling, which creates an enormous amount of uncertainty and makes it difficult to plan during the year, as to whether a tax credit will be achieved? I urge the Minister to make a small change and denominate those figures and values in sterling.

John Healey: If the hon. Gentleman checks the record, he will realise that he just asked me why we were denominating in sterling, but then urged that we do denominate in sterling.

Adam Afriyie: Excuse me, I meant euros.

John Healey: I thought that that was what the hon. Gentleman meant, but it was not quite what he said.
In a sense, the approach that we have taken is the established approach in the tax system. Clause 48 makes a minor amendment. It does not seem sensible at this point to make such a significant amendment as that which the hon. Gentleman has suggested.

Question put and agreed to.

Clause 48 ordered to stand part of the Bill.

Clause 49

Research and development tax relief: definition of SME etc

Question proposed, That the clause stand part of the Bill.

Adam Afriyie: I had not wished to speak on this occasion, but I want to re-emphasise the point that we have a great opportunity in this clause to denominate in sterling, not in euros. I did not find the Financial Secretary’s previous answer in any way satisfactory or reassuring, given the hundreds and possibly thousands of businesses that will be at those thresholds. I wonder whether he can reflect a little longer and give a reasoned answer as to why we are denominating in euros rather than in sterling, which seems to cover every other aspect of the Bill. I understand tradition and convention, but will he give a clear answer as to why he wants to perpetuate that uncertainty for those businesses?

John Healey: If the hon. Gentleman studies the provisions covering the research and development tax reliefs and the vaccine research relief, he will see that some of the qualifying criteria that we use for companies are established at the European level. As he will appreciate, not only do we have to take into account the size of a company, based on the definitions of small or medium-sized companies and large companies, but, where turnover or similar criteria or tests apply, we have to use the European set standard, which is denominated in euros.
The reason we have to take account of those criteria is that, in order to put in place a tax relief system such as the one that we have for research and development, it must receive clearance under the state aid rules. In other words, we are restricted in our ability to introduce direct support to firms for particular activities and policy purposes in the UK, in order to ensure that it is consistent with state aid rules. That is the established process within the European Union, to which we signed up as part of our membership of the Union and the single market. Where the European Commission exercises its judgment in setting criteria, it denominates in euros. We have transferred that approach into our domestic legislation, and have done so from the start.
As I said on clause 48, we are making what are, in essence, minor or technical amendments to the operation of the tax reliefs. Therefore, it is not appropriate to revisit questions about the integral design of the approach that we have established for R and D tax relief since 2000.

Question put and agreed to.

Clause 49 ordered to stand part of the Bill.

Clause 50 ordered to stand part of the Bill.

Schedule 16

Venture capital schemes etc

Vincent Cable: I beg to move amendment No. 181, in schedule 16, page 200, line 4, leave out ‘50’ and insert ‘250’.

Eric Illsley: With this it will be convenient to discuss amendment No. 182, in schedule 16, page 200, line 10, leave out ‘50’ and insert ‘250’.

Vincent Cable: This is my first contribution to the work of the Committee. It is a tribute to the excellence and stamina of my hon. Friend the Member for Falmouth and Camborne that we have not had to make more use of those on the substitute’s bench.
These are probing amendments. Our understanding is that there is at present a restriction on the size of companies—from 250 to 500 employees—that can take advantage of the reliefs, and that the Government are imposing this restriction because of limitations set by the European state aid rules. In essence, the purpose of the amendments is to try to establish the Government’s thinking behind the legislation.
The state aid rules are summarised in a set of guidelines that were produced last year, “Community guidelines on state aid to promote risk capital investments in small and medium-sized enterprises”. We understand that the Government must comply with the rules, but we have some questions about them.
A quick reading of the European guidance suggests that Governments have a fair degree of flexibility in interpreting the rules. The first question is why the Government have interpreted the provision in such a restrictive way. Many medium-sized companies will be removed from the provisions on venture capital because of this legislation. Could the Minister explain why he had to interpret the European rules in this way?
It appears that the Government have set the maximum restriction, with a number of employees—50—that is below the present level. On the other hand, it appears that the number of employees has increased for R and D tax credits, which are also governed by European state aid rules. We are trying to understand why the rules should be interpreted in a particularly permissive way for R and D tax credits but in a more restrictive way for venture capital.
The Institute of Chartered Accountants in England and Wales is particularly perturbed by this measure because its judgment, which is based on its research, is that venture capital measures are more helpful than the R and D tax credit in encouraging innovation by this group of companies. The institute cannot understand why the Government have apparently moved in the opposite direction. They have reduced the range from 250, which is the normal threshold for medium-sized companies, to 50, which is the threshold for small companies. What in the guidelines required the Government to make that shift for these provisions but not for the R and D tax credits?
There may be perfectly good legal reasons for the wording in the schedule. We understand that the Government have to comply with the guidelines, but, given that the rules offer some flexibility, we wish to find out from the Minister why he has interpreted them in this way.

Mark Hoban: I want to echo the hon. Gentleman’s comments. We see in the Red Book that the changes to various venture capital schemes have been made in response to the new guidelines on state aid that were published last year. Like him, I am rather surprised that the Government have felt the need to make the changes, as it appears from examining those rules that if a robust case has been made and there is evidence to back it, the EU is prepared to grant exemptions.
For example, in paragraph 5.1(a) of the rules there is a safe harbour whereby an investment below €1.5 million is not deemed to be state aid, and if a member state can produce evidence of a market failure affecting that limit, state aid can be used in connection with stimulating small and medium-sized enterprises. In paragraph 5.1(b) permission is given for Governments to support schemes providing finance to medium-sized companies. Does the Financial Secretary believe that firms employing 50 full-time equivalents are medium sized? I am not sure whether I would see them as medium-sized businesses.
There are other examples in the state aid rules that would create an exemption allowing the Government to continue with venture capital trusts and perhaps set a more generous level. Will the Financial Secretary clarify whether the Commission has given approval to the VCT rules as set out in the Bill? The Red Book is a little opaque as to whether that permission has been received. It would be useful to know whether it has, and to understand more about the case that the Government employed for retaining the status quo prior to the schedule being introduced. The hon. Member for Twickenham also highlighted, appropriately, the contradiction between this schedule and schedule 15—a more generous number of employees is set for R and D tax credits and a tight number for venture capital schemes.
I congratulate the Treasury, for a change, on other changes made in the schedule. On Report of last year’s Finance Bill I discussed an amendment on the 70 per cent. rule, and we also debated inadvertent breaches. I am grateful to see, a year later, that the Minister has listened to my representations and that those changes are in the schedule.

John Healey: I welcome the hon. Member for Twickenham to the Committee’s proceedings. If the Liberal Democrats have that sort of quality on the substitutes’ bench, they match Chelsea. It is a pleasure to see him reappear. [Interruption.] Indeed—they did not actually win this year, but there we are.
Why have we interpreted the rules as we have? As we set out in the Budget text, we are required to introduce the employee head count test, on which the hon. Gentleman focused his questions, to meet the requirements of the European state aid obligations. I shall be honest with the Committee: we did not want to introduce the head count test or the new employee limit. We are acting essentially to ensure that we can secure the future of the venture capital schemes.
The corporate venturing scheme, the enterprise investment scheme and the venture capital trusts are important elements in helping to tackle the equity gap, but to continue they need to meet the state aid requirements set out by the European Commission, particularly the new state aid rules on risk capital that were introduced last August. We have spent a good deal of time and effort, particularly since then, on submitting strong evidence about UK market failures in such investment.
Our situation is not necessarily the same as that of other European states, particularly as we have a mature market. Of course, the state aid risk capital rules, with some flexibilities, are designed to apply across Europe. We argued that we need national policy measures if we are to respond to the structural problems affecting our national capital markets. The Commission did not accept our argument that the additional provision that we wanted to make in all areas for mid-size companies—the sort of provision that is set out in these amendments—would be compatible with the Common Market.
If we were to persist with that approach or, indeed, if we were to amend the Bill in the way that the amendments suggest, it would bring the continuation of these schemes into question. Therefore, we will continue to propose amendments and to discuss the matter. I hope that, in conjunction with the industry, we can collate further evidence that might encourage the Commission to make greater use of the flexibilities that can be found within the rules that it introduced last year. For the moment, our schemes need to be judged as compliant by the Commission by August this year. Because of our detailed discussions with the Commission, particularly in the past 12 months, I am confident that we will get clearance. However, we have not formally had it yet.
Finally, I welcome the comments of the hon. Member for Fareham on our amendments about the inadvertent breaches and the 70 per cent. rule. He did indeed raise those points in our discussions last year, and I took them seriously. They were raised by others as well and we have had the chance to examine them over the past 12 months. For that reason, I am glad that we have able to cover them in the Bill.

Vincent Cable: Will the Minister comment on the further point that both the hon. Member for Fareham and I have raised, which is: if the Commission was so tough on the 50-employee rule, why were the Government allowed to move in the opposite direction on the R and D tax credits scheme? Does a different set of principles apply, or is there an inconsistency in the Commission?

John Healey: The rules that we are trying to meet in the three schemes are set out in the state aid risk capital rules, which were introduced by the Commission in August last year. They clearly apply to this policy territory, but they do not apply in the same way to the R and D tax credits. The changes that we are making to the R and D tax relief scheme are being made not because we are required or encouraged to do that by the Commission, but because we have established that there is evidence of under-investment in innovation and research and development by mid-size companies. It is an area of the economy that we want to support, and in which we want to see greater activity. There is clear evidence and a clear policy purpose for what we are proposing in the R and D tax credits. The circumstances that apply there are different from those that apply to venture capital and EIS schemes.

Vincent Cable: I want to acknowledge that the Government have confirmed on the record that they approached the Commission and pushed as hard as they could on this point. We have accepted in this short exchange the potential for damage to middle-level companies in the industry, which is a particular problem for regional funds that are struggling to establish themselves. However, I accept what the Government say. It was pointed out to me that the Chartered Institute of Taxation has accepted that the Government have done the best that they can. The Institute of Chartered Accountants in England and Wales was a little more sceptical, but I accept the Minister’s word that he has tried and that this is the most that can be done within the rules. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

John Healey: I beg to move amendment No. 165, in schedule 16, page 205, line 39, leave out from beginning to ‘for’ and insert—
‘(1) Paragraph 29 of Schedule 15 to FA 2000 is amended as follows.
(2) In sub-paragraph (3),’.

Eric Illsley: With this it will be convenient to discuss Government amendments Nos. 166 to 174 and 159 to 164.

John Healey: I shall be brief, unless members of the Committee want to dwell in detail on any of these measures. Government amendments Nos. 166 to 174 concern paragraphs 9 to 11 to schedule 16 and are designed to bring two improvements that will benefit companies seeking to raise finance under the enterprise investment scheme, the corporate venturing scheme and the venture capital trust scheme.
Government amendments Nos. 159 to 164 attempt to achieve the same thing in relation to the enterprise management incentives legislation. They provide first for the transfer of relevant intangible assets within a corporate group structure to newly incorporated subsidiaries, thus providing a greater flexibility for the venture capital schemes. Clause 60 makes the equivalent changes to the enterprise management incentives legislation. The changes have been welcomed by the Enterprise Investment Scheme Association—Opposition Members will be familiar with its chairman, who is doing a good job—and respond to a good dialogue that we have with the sector in recent months.
We have also had good discussions with interest groups that have raised further technical points, so we have tabled amendments to ensure that some technical changes to the legislation mean that it achieves its objectives. I commend these amendments to the Committee.

Amendment agreed to.

Amendments made: No. 166, in schedule 16, page 206, line 2, leave out from ‘company’ to end of line 3 and insert
‘throughout a period during which it created the whole or greater part (in terms of value) of the intangible asset.”
(3) After sub-paragraph (6) insert—
“(7) If—
(a) the issuing company acquired all the shares (“old shares”) in another company (“the old company”) at a time when the only shares issued in the issuing company were subscriber shares, and
(b) the consideration for the old shares consisted wholly of the issue of shares in the issuing company,
references in sub-paragraph (3) to the issuing company include the old company.”
9A In paragraph 86(2) (substitution of new shares for old shares), after “Schedule”, in the first place it occurs, insert “(except paragraph 29(7))”.’.
No. 167, in schedule 16, page 206, line 9, leave out from ‘company’ to end of line 10 and insert
‘throughout a period during which it created the whole or greater part (in terms of value) of the intangible asset.”,’.
No. 168, in schedule 16, page 206, line 12, at end insert ‘, and
(c) after subsection (5C) insert—
“(5D) If—
(a) the company mentioned in section 293(1) (“the issuing company”) acquired all the shares (“old shares”) in another company (“the old company”) at a time when the only shares issued in the issuing company were subscriber shares, and
(b) the consideration for the old shares consisted wholly of the issue of shares in the issuing company,
references in subsection (5) above to the company mentioned in section 293(1) include the old company.”
(1A) In section 304A of that Act (acquisition of share capital by new company)—
(a) in subsection (3), after “Chapter” insert “(except section 297(5D))”, and
(b) in subsection (4), after “Chapter” insert “(except section 297(5D))”.’.
No. 169, in schedule 16, page 206, line 18, at end insert—
‘(2A) In section 576K of that Act (share loss relief: substitution of new shares for old), after subsection (3) insert—
“(4) Nothing in subsection (2) applies in relation to section 195(7) of ITA 2007 as applied by section 576B(7) above for the purposes mentioned in section 576B(8).”’.
No. 170, in schedule 16, page 206, line 23, at end insert—
‘(3A) In section 146 of that Act (share loss relief: substitution of new shares for old), after subsection (2) insert—
“(3) Nothing in subsection (2) applies in relation to section 195(7) as applied by section 137(7) for the purposes mentioned in section 137(8).”’.
No. 171, in schedule 16, page 206, line 29, leave out from ‘company’ to end of line 30 and insert
‘throughout a period during which it created the whole or greater part (in terms of value) of the intangible asset.”,’.
No. 172, in schedule 16, page 206, line 31, at end insert ‘, and
(c) after that subsection insert—
“(7) If—
(a) the issuing company acquired all the shares (“old shares”) in another company (“the old company”) at a time when the only shares issued in the issuing company were subscriber shares, and
(b) the consideration for the old shares consisted wholly of the issue of shares in the issuing company,
references in subsection (4) to the issuing company include the old company.”
(5) In section 249 of that Act (substitution of new shares for old shares)—
(a) in subsection (2), after “Part” insert “(except section 195(7))”, and
(b) in subsection (4), after “Part” insert “(except section 195(7))”.’.
No. 173, in schedule 16, page 206, line 37, leave out from ‘company’ to end of line 38 and insert
‘throughout a period during which it created the whole or greater part (in terms of value) of the intangible asset.”’.
No. 174, in schedule 16, page 206, line 39, at end insert—
‘(4) After that subsection insert—
“(7) If—
(a) the relevant company acquired all the shares (“old shares”) in another company (“the old company”) at a time when the only shares issued in the relevant company were subscriber shares, and
(b) the consideration for the old shares consisted wholly of the issue of shares in the relevant company,
references in subsection (4) to the relevant company include the old company.”’.—[John Healey.]

John Healey: I beg to move amendment No. 175, in schedule 16, page 210, line 27, leave out ‘wholly for money’ and insert ‘,
(aa) the consideration for the disposal does not consist wholly of new qualifying holdings’.

Eric Illsley: With this it will be convenient to discuss Government amendments Nos. 176 to 180.

John Healey: Quite simply, the amendments would enable venture capital trusts to dispose of investments that they have held as qualifying holdings for a period of at least six months for cash without jeopardising their approval status for the following six months. The change has been widely welcomed by commentators across the industry. The director general of the Association of Investment Companies, for instance, said:
“We have had an extremely constructive dialogue with the Government over this issue and are delighted with this decision.”
The amendments would widen the scope of the disregard rules to cover disposals made wholly or partly for consideration other than cash and have again been warmly and widely welcomed by representatives from the sector. I commend them to the Committee.

Amendment agreed to.

Amendments made: No. 176, in schedule 16, page 210, line 35, after ‘disposal’ insert ‘(but see subsection (3A))’.
No. 177, in schedule 16, page 210, line 37, leave out ‘money obtained from’ and insert ‘any monetary consideration for’.
No. 178, in schedule 16, page 210, line 41, at end insert—
‘(3A) If the consideration for the disposal includes new qualifying holdings, subsection (2)(a) has effect as if the reference to the holding were to the appropriate proportion of the holding (the value of which is that proportion of the value of the holding, determined in accordance with subsection (3)).
(3B) The appropriate proportion is—  TC — NQH  TC
where—
TC is the market value (at the time of the disposal) of the total consideration for the disposal, and
NQH is the market value (at that time) of the new qualifying holdings.’.
No. 179, in schedule 16, page 211, line 4, at end insert—
‘(4A) “New qualifying holdings” means shares or securities which (on transfer to the company) are comprised in the company’s qualifying holdings.’.
No. 180, in schedule 16, page 211, line 7, at end insert—
‘(6) Nothing in this section applies in relation to disposals between companies that are merging (within the meaning of section 323).’.—[John Healey.]

Schedule 16, as amended, agreed to.

Clause 51

Real Estate Investment Trusts

Question proposed, That the clause stand part of the Bill.

Edward Balls: With your permission, Mr. Illsley, it might be possible to discuss our amendments to schedule 17 while we debate clause 51, as it introduces the schedule. I will be guided by you.

Mark Francois: For procedural reasons that will become apparent, I would rather do clause 51 first and then come on to the amendments.

Eric Illsley: We will start with clause stand part and take it piece by piece.

Mark Francois: I hope my reasons will become apparent, and I welcome you to the Chair, Mr. Illsley.
Last year, during the Finance Bill, I debated with the Economic Secretary the introduction of the new regime of real estate investment trusts, which subsequently went live in the United Kingdom on 1 January 2007. Since that time, the Government have had the opportunity to consider the initial operation of the scheme. Via clause 51 and the associated schedule 17, they have introduced what might be characterised as a number of tweaks to the regime, designed to improve its operation. Unfortunately, some important issues have still not been addressed.
Clause 51, which introduces the schedule, allows some of the changes contained therein to be backdated to the introduction of the introduction of the REIT regime on 1 January. Moreover, the changes proposed in schedule 17 include relaxing some of the qualifying conditions that must be met in order to achieve REIT status. That the Government are still tweaking the REIT regime is evidenced by the fact that schedule 17 is now being amended by 20 Government amendments—amendments Nos. 138 to 158—which in practice all relate to demergers and are largely corrective. In other words, they represent a further tweaking of the tweak.
I have relatively little to say about the Government’s drafting amendments to schedule 17, aside from an important procedural point that I shall come to when we get there. However, I want to give you notice, Mr. Illsley, that when we come to schedule 17 stand part, I want to raise several points about the schedule and how it effects the REIT regime to date and in the future.

Question put and agreed to.

Clause 51 ordered to stand part of the Bill.

Schedule 17

Real Estate Investment Trusts

Edward Balls: I beg to move amendment No. 138, in schedule 17, page 214, line 11, leave out ‘transfers’ and insert ‘disposes of’.

Eric Illsley: With this it will be convenient to discuss Government amendments Nos. 139 to 158.

Edward Balls: I shall be brief because it is clear that the hon. Gentleman does not intend to raise detailed issues about the amendments. It is for you to make a judgment, Mr. Illsley, but from my point of view it would be fine if we range widely.
The clause that we have just agreed to introduces schedule 17, which amends provisions in part 4 of the Finance Act 2006. As the hon. Gentleman reminded us, we debated that set of clauses in great detail a year ago in a spirit of co-operation, and we made progress in mutual understanding of some of the issues.
The regime came into force on 1 January after some years of detailed and constructive consultation and engagement with the industry. By allowing indirect investment in property to enjoy the same tax treatment as direct investment, the UK REIT regime will improve the quality and quantity of finance for investment in property, promoting a wider range of savings products for individual investors and supporting structural change in property markets
I am pleased to say that the UK REIT regime is already proving a success with 13 companies converting to the regime from a wide variety of sectors, and now a 14th company setting up with the express purpose of being a UK REIT. The total market capitalisation of the UK REIT sector is now £35 billion, and two of the UK REITs include both commercial and residential property in their portfolios.
Since last year’s Finance Bill, we have continued our consultation with the industry to ensure that the regime works as effectively as possible. The changes in the schedule are the result of that consultation and were announced at the time of the pre-Budget report. As the hon. Gentleman suggested, they are minor changes clarifying some of the definitions and powers in the existing legislation.
We also announced at the time of the pre-Budget report that we would introduce changes to the regulations to extend the regime to make it easier for companies to become UK REITs, and the Chief Secretary circulated draft regulations for that purpose to Committee members on 9 May.
Since publication of the draft clause and schedule at the end of March, the Law Society has come forward with a further representation on the technical detail of the regime as it relates to demergers from UK REITs. Continuing that spirit of consultation, we are keen to accommodate those points, hence the amendments.
I am happy to respond to questions or requests for clarification, although I have the impression from remarks by the hon. Gentleman on the previous clause that he accepts that these are minor, technical drafting amendments.

Mark Francois: It is entirely up to the Economic Secretary to decide how to play this, but I prefer briefly to debate the amendments first, and then to move on to schedule stand part, but I am in your hands, Mr. Illsley.

Edward Balls: Given that the hon. Gentleman made some introductory remarks about the REIT regime, I was making some introductory remarks about it, too, and the changes that we are making in the schedule. It is for him to decide how he frames the debate, but I thought it would be helpful for me to put on the record for hon. Members the context within which his detailed points occur.
As I understand it, his detailed points do not concern the amendments, but given that the amendments are to the schedule and that they and the wider context cannot be understood without understanding the schedule, I thought it would be helpful to make a few remarks about the schedule. However, I shall be guided by you, Mr. Illsley.

Eric Illsley: We are discussing the amendments, and if the hon. Member for Rayleigh then wants a stand part debate on the schedule, the whole aspect of it can be debated then. He can speak just to the amendments at this stage.

Edward Balls: Then I am very happy to sit down now and wait until the schedule stand part debate.

Mark Francois: We got there in the end. As I said in my remarks on clause 51, these amendments are essentially drafting in nature. They modify the elements of the schedules specifically relating to demergers. As such we have no quarrel with them and I have only one specific question to put to the Minister about them. However, there is a procedural point which I do not want to let pass without comment. I raise it more in sorrow than in anger because last year we debated REITs in a rather consensual manner and managed to cover a lot of the detail as a result.
We have already had one occasion in Committee when Ministers were taken to task because details of draft Government regulations had been circulated in advance to selected members of the Committee but unfortunately not to others. After that, as I recall, Ministers, including the Chief Secretary, apologised to the Committee and said that they would do their best to prevent that sort of thing from happening again. However, when I returned to my office this lunchtime, newly arrived in my e-mail inbox was an electronic copy of a letter dated 16 May from the Economic Secretary to my hon. Friend the Member for Chipping Barnet. According to the electronic copy, there was a hard copy for the hon. Member for Falmouth and Camborne, the Chairman and Clerk of the Committee, but to no one else. Among other amendments, it refers to the REITs amendments, which we are debating this afternoon, and it was the first time that I had seen or heard of that letter.
If Ministers are going to write to members of the Committee explaining the reasoning behind their amendments, which is a laudable aim and quite often the right thing to do, could they please try harder to ensure that they circulate the information to everyone on the Committee—Back Benchers and Front Benchers—as simple courtesy would suggest? As this has already happened once on this Committee, I hope that we will not get a hat trick. I make a plea through you, Mr. Illsley, that Ministers do their best to take this point on board. If the Minister wishes to intervene, I will sit down, but I still have a question for him.

Edward Balls: I conducted the Finance Bill on the REITs clauses. I remember us having a substantive consensual discussion, with some areas on which there was disagreement. As I understand it, we have operated this year in exactly the same way as in previous years in ensuring the circulation of letters and amendments to members of the Committee. I am happy to be corrected by the hon. Gentleman if there has been a change in our procedure. As I understand it, we have done things in the same way as in previous years when no difficulty arose at all.
I do not know whether there is a problem because once again the circulation has not been carried out by the Committee Clerks or the hon. Member for Chipping Barnet has not circulated it to her colleagues. The hon. Gentleman said that he was making his point more in sorrow than in anger. If he suggests that there has been a procedural mistake, it would be helpful to us if he specified what we have done differently this year from last year so that we can rectify it.

Eric Illsley: Order. To clarify matters for the Committee, as far as the Chair and the Clerks are concerned, any correspondence from a Minister to members of the Committee should go to every member of the Committee. That is the limit of the Chair’s involvement. It is a matter for the Government and members of the Committee.

Mark Francois: I am grateful for that clarification, Mr. Illsley. I do not think that we want to do this to death, but as I understand it, it is not the responsibility of the Clerks to ensure that members of the Committee get correspondence from the Minister; it is the Minister’s responsibility. I hope that this will not happen again and that we can move on.

Edward Balls: Will the hon. Gentleman give way?

Mark Francois: I will, but the Minister has heard the Chairman’s ruling. I know that he is new to this game, but he would be wise to listen to it.

Edward Balls: As the hon. Gentleman said, last year we went about these matters in a very different way from the way that he is choosing to go about them this year. I should like to understand what accusation he is making. Is he suggesting that we have changed the way we do things this year compared with last year? If so, is he saying that it was done in order to prevent him from having sight of the regulations? If that is the accusation, I refute it entirely, and am upset by the insinuation that he is making.

Mark Francois: As I said, we will not do this to death.

Edward Balls: We have done it to death already.

Mark Francois: I am not accusing the Minister of not letting me see the regulations—they are amendments, not regulations. I am saying that he wrote to some Committee members explaining the rationale behind those amendments, but not to others. My understanding is that, normally, when a Minister does that, he should write to all Committee members. He cannot just e-mail one or two and expect them to circulate it on his behalf. That is my understanding; I think that you have confirmed from the Chair, Mr. Illsley, that, as a rule of thumb, if a Minister writes to one Committee member with information relevant to a debate, he should write to everybody.
So that the Minister understands me, let me say that I behaved as I did simply because this has happened once already in the Committee and we were told, in essence, that it would not happen again. It has happened a second time, so I did what I did. I hope that he understands that and that it will not happen a third time. I hope that the lesson can be learned. With that, I would like to ask the Minister about the amendments, which I believe, he is here to answer. Amendment No. 138 replaces the word “transfers” with the words “disposes of” an asset—others make similar provisions. For clarity, will the Minister explain the technical reasoning behind that change in drafting?

Edward Balls: I am happy to explain the thinking behind all the amendments. As I said, we put the amendments out to consultation, and since their publication, the Law Society has made further representations on the technical details of the regime for demergers from UK REITs. The Government amendments will ensure that schedule 17 provisions relating to demergers within UK REITs apply where a demerged property or subsidiary is transferred to a new company that then becomes a UK REIT itself.
The amendments will ensure also that the terminology used to describe the demergers is consistent with that used elsewhere in UK REITs legislation by using the word “disposal” rather than “transfers”. Amendment Nos. 138 to 148 will mean that the provisions in paragraph 11 of schedule 17 will apply to a company that acquires a subsidiary company to which the ring-fenced assets have been transferred. The amendments allow also the company time to satisfy the conditions for entry to the UK REITs regime. That extends the same flexibility to disposals of ring-fenced assets by a single company UK REIT, as paragraph 16 proposes already for demergers from group UK REITs. That accords with our policy of aligning the treatment of single company and group UK REITs.
Amendments Nos. 149 to 158 will mean that the provision in paragraph 16 of schedule 17 will apply where a demerged company becomes a member of a new group UK REIT, rather than, as originally provided for, a parent of such a group. In summary, the amendments ensure that schedule 17 provisions relating to demergers from UK REITs have their intended scope and include additional flexibility. Just to be clear, amendments Nos. 138, 142, 146 and 147 substitute “disposal” for “transfer”, which will mean that the terminology in that part of the Bill is consistent with other sections of UK REITs legislation—for instance, section 125(2) of the Finance Act 2006, which deals with the movement of assets outside the ring fence, as well as chargeable gains legislation.

Amendment agreed to.

Amendments made: No. 139, in schedule 17, page 214, line 13, after ‘S’ insert ‘to another company (“P”),’.
No. 140, in schedule 17, page 214, line 14, leave out ‘on the date of the transfer of the asset, S’ and insert
‘on the date when it acquires the interest in S, P’.
No. 141, in schedule 17, page 214, line 15, after ‘109’ insert
‘(as modified by paragraph 8 of Schedule 17)’.
No. 142, in schedule 17, page 214, line 17, leave out ‘transfer’and insert ‘disposal of the asset’.
No. 143, in schedule 17, page 214, line 18, leave out ‘S’ and insert
‘the group of which S is a member’.
No. 144, in schedule 17, page 214, line 19, at end insert—
‘( ) P may give a notice under section 109 (as modified by paragraph 8 of Schedule 17) in accordance with subsection (1)(c) even if it does not expect to satisfy Conditions 3 to 6 of Section 106 throughout the accounting period specified in the notice.’.
No. 145, in schedule 17, page 214, line 21, leave out ‘S’ and insert
‘the group of which S is a member’.
No. 146, in schedule 17, page 214, line 22, leave out ‘transferred’ and insert ‘disposed of’.
No. 147, in schedule 17, page 214, line 24, leave out ‘transfer’ and insert ‘disposal’.
No. 148, in schedule 17, page 214, line 25, at end insert—
‘( ) But if, at the end of the period of six months mentioned in subsection (1)(c), Conditions 3 to 6 in section 106 are not satisfied in relation to P, subsection (2) shall be treated as not having had effect.’.
No. 149, in schedule 17, page 215, line 13, after ‘group’ insert ‘(“Group 1”)’.
No. 150, in schedule 17, page 215, line 16, leave out ‘the group,’ and insert ‘Group 1,’.
No. 151, in schedule 17, page 215, line 19, leave out ‘the principal company of a group’ and insert
‘a member of another group (“Group 2”)’.
No. 152, in schedule 17, page 215, line 22, leave out ‘it’ and insert
‘the company (or the principal company of Group 2)’.
No. 153, in schedule 17, page 215, line 24, leave out ‘the group,’ and insert ‘Group 1,’.
No. 154, in schedule 17, page 215, line 27, leave out ‘the group.’ and insert ‘Group 1.’.
No. 155, in schedule 17, page 215, line 34, leave out ‘the principal company’ and insert ‘a member’.
No. 156, in schedule 17, page 215, line 36, leave out ‘the group.’ and insert ‘Group 1.’.
No. 157, in schedule 17, page 216, line 3, leave out ‘the principal company’ and insert ‘a member’.
No. 158, in schedule 17, page 216, line 5, leave out ‘the group.’ and insert ‘Group 1.’.—[Ed Balls.]

Question proposed, That this schedule, as amended, be the Seventeenth schedule to the Bill.

Mark Francois: Schedule 17 contains a number of detailed changes to the REITs regime, which began operation on 1 January 2007. For instance, paragraph 2 of the schedule alters the definition of the types of loans that REITs may undertake without breaching the regime, and paragraph 3 modifies the restriction on income from owner-occupied property that REITs are allowed to generate. We debated that last subject in considerable detail last year, under what is now part 4 of the Finance Act 2006.
Paragraph 5 amends section 109 of the Finance Act 2006, effectively allowing certain previously non-listed companies to benefit from the REITs regime. That relates specifically to close companies which technically have difficulty in satisfying the requirements of the REITs regime on their first day as listed companies. It is a modest relaxation of the section 109 requirements, about which the British Property Federation said:
“There is currently a problem for new REITs at the time of listing and converting to REIT status because there could be a very short period during the first day of converting, when they were not actually listed.”
The Opposition welcome the changes so far as they go. However, even when revised by the 20 Government amendments that have been tabled, the changes proposed by the schedule still do not address two key issues on the REITs regime that were highlighted to the Economic Secretary by the Opposition a year ago.
The first issue is the continuing denial of REITs status to those companies listed on the alternative investment market of the London stock exchange—AIM, as it is more popularly known. According to recent figures from the British Property Federation, some 14 companies with a total market capitalisation of some £36 billion have converted to UK REITs status since 1 January 2007. That figure looks impressive at first glance, but it is important to note that approximately £30.1 billion of that value—more than three quarters—is represented by just five companies: Land Securities, with £9.4 billion, British Land, with £7.8 billion, Hammerson with £4.8 billion, Liberty International at £4.5 billion, and SEGRO at £3.6 billion. In other words, the regime has been dominated to date by the larger property companies, which were always likely to convert to REIT status.
The British Property Federation argued in its May 2007 briefing, which lists the 14 REITs that have converted so far, that:
“Whilst this represents an encouraging start it should be noted that the above list is almost entirely represented by those existing, listed property companies that have always been viewed as best placed to convert to REITs.”
The federation goes on to say:
“We have concerns that, under the current legislative framework for UK-REITs the medium/long-term growth of the UK-REIT market will be limited and that actions need to be taken in the short term in order to address these concerns.”
That brings me to the issue of allowing REITs to be listed on AIM as well as on the principal stock exchange. As the Economic Secretary will recall, we debated that issue as well in considerable detail last year, including on Report. So that it is not said that I have misquoted him, let me say that he did not commit to launching a formal review—he was clear about that, and I remember what he said. He did, however, say that he would keep the issue broadly under review. I hope that I have not misrepresented him. In light of that, is it still Government policy that REIT status should be denied to property companies that are listed on AIM, even at the risk of inhibiting the potential growth of the UK REITs market? In other words, has the Government’s position moved since last year?
The second important issue that the changes to schedule 17 fail to address, and which the Economic Secretary should likewise recall from last year’s debates, is the lack of establishment of residential property REITs. Those established so far have been almost entirely commercial property REITs. On that point, the British Property Federation said:
“It is noticeable that there is no material residential property within the existing REIT regime. This is despite the fact that the development of a tax efficient listed residential property market and the wider benefits that this could bring to the UK economy was one of the key policy objectives for introducing UK REITs.
The UK Government should actively seek to use the REIT structure as a tool to encourage the growth of a listed residential sector. This will be achieved by working with the industry to develop the REIT regime so that it is more suitable for a residential business model.”
When I raised that issue with the Economic Secretary last year in Committee, in advance of the launch of the new regime, he said:
“Over the course of this year and not just when the regime begins, we will be monitoring closely whether residential companies enter the regime. I explained that I was not surprised that early indications had come from the commercial sector, because of its larger scale and sophistication, but I also said that there had been private and public indications that residential property companies would come forward.”—[Official Report, Standing Committee A, 8 June 2006; c. 507.]
He then committed to keep that matter as well under review during the year ahead.
Almost a year on, and now that the regime has been operating since January, will the Economic Secretary explain to the Committee why, despite his encouraging prediction a year ago, the REIT regime remains overwhelmingly dominated by commercial property and hardly any residential property companies have converted to REIT status? He attempted to fudge it by saying that two REITs had both a commercial and a residential property element, but a REIT can have a very small residential property element and still meet that description. Have any out-and-out residential REITs entered the regime? I ask because, if part of the Government’s aim was to create a REIT regime to foster the development of new residential housing, particularly affordable housing, they appear to have failed thus far in that important objective. I should like to press the Economic Secretary to reply to those points.

Stewart Hosie: I mirror some of those questions. Debate on Report last year was particularly heated about allowing REITs to be created not simply with full stock exchange listings but by other means of funding. I recall perfectly well that throughout the process, the Economic Secretary said—I think that it was in good faith—that he would monitor the situation and keep it under review. I mirror the questions asked, particularly in relation to small REITs providing social housing. Many of us saw a great deal of potential in the tax benefits of REITs that do not require the massive start-up costs of a full stock exchange listing.
I also have a question about schedule 17. Paragraph 7(b) deals with section 116, “Minor or inadvertent breach”. Proposed new subsection 3A(b) states:
“The regulations may make provision about, or by reference to, anything done by or in relation to a company or any sum arising or treated as arising...in the calendar year during which the regulations are made”,
rather than the financial year, tax year or accounting year. Why is the calendar year specified?

Edward Balls: I shall investigate the matter brought before the Committee earlier about the circulation of proposed amendments and I shall happily give a full report in writing to you, Mr. Illsley, and to all Committee members. If the Treasury, my office or I have failed in any way to follow the proper and normal procedure for circulating amendments to all Committee members, I will wholeheartedly and unreservedly apologise. I am unclear about whether we have made such an error, and because of how the hon. Member for Rayleigh chose to raise the issue, I have not been able to find out—

James Duddridge: Perhaps I can help to clear up the point absolutely so that the Economic Secretary can apologise now to Committee members. As a Back-Bench member, I did not receive that communication as I expected to. I found that disrespectful to all Committee members.

Edward Balls: As the hon. Member for Rayleigh said, I have served on only two previous Finance Bills, so I am still a novice compared with him in the procedures and courtesies. That is why I said that I shall look into the matter. If I find that we have made a mistake, I shall apologise unreservedly. I fear that, like me—perhaps more than me—the hon. Member for Rochford and Southend, East is a novice in such matters. He would do better to wait for me to look into the issue before he reaches a judgment.

Mark Francois: I made my point in that way because the problem appeared to have occurred twice in the Committee. If the Minister will listen, I will say that I will take him at his word. Last year, he dealt with the issue courteously. If he agrees to look into the matter, I hope that he will discover exactly what happened. I genuinely think that there has been a mistake, and that is why I raised it. I understand that the Minister will look into it. We shall try to establish exactly what did and did not transpire.
Can we make it the norm that everything should be circulated to Committee members? That is normally what happens and it would avoid problems in the future. I hope that the Minister will take my comments at face value and that he will go back and double check.

Edward Balls: As I said, I am very happy to do so; indeed, I said that I would. I have always endeavoured to conduct myself with Opposition Committee members in a courteous and proper manner when it comes to how we go about these proceedings. It seems entirely appropriate that we should disagree on the politics; however, in my previous debates with the hon. Member for Rayleigh, I have always conducted myself in that courteous manner. Indeed, when the issue arose last week—I had had no knowledge of it until the Committee started—I said not only that if we had made a mistake we would apologise, but that I would shift us from negative to affirmative procedure to clear up the matter if that could be done in consultation with the business managers.
Obviously, like the hon. Gentleman, I am annoyed—to put it mildly—at the possibility that normal past procedures have not been followed. I shall look into that.

Eric Illsley: Order. For the sake of the rest of the Committee, we will draw a line there. The Minister will do his checks; we should now return to the debate.

Edward Balls: I am happy to take your guidance, Mr. Illsley.
I turn to the schedule and the two questions raised by the hon. Gentleman. As I said, the schedule makes some minor changes to the existing legislation. The definitions of profits, financing costs and owner-occupation now work in the same way for group and single-company UK REITs. The definition of derivative contracts has been extended to make it clear that such contracts that hedge risk in relation to liabilities in the property rental business, as well as assets, are covered.
The condition prohibiting profit-linked loans has been relaxed so that companies can use ratchet loans, in which the interest rate for borrowing money reduces as profits increase. The proposed legislation also clarifies the powers of the special commissioners in respect of appeals and ensures that charities are exempt from tax on distribution from UK REITs.
I turn to the extension of the regime. The changes will make it easier for companies, particularly new listed ones, to become UK REITs. Companies will no longer need to be listed on a recognised stock exchange before they give notice to join the regime but will be able to join on the first day on which they are listed. The changes also allow companies to join the regime if they cannot meet the asset test on the first day on which they enter it. That will make it easier for newly established or newly listed companies to join, by allowing them time to acquire rental properties.
As announced at the PBR, there will be a tax charge if the company breaches the asset test on day one of entry to the regime, the detail of which is contained in the Real Estate Investment Trusts (Breach of Conditions) (Amendment) Regulations 2007. A draft copy of the regulations has been made available. Following consultation on them, we propose a further relaxation so that failure to meet the asset test at the beginning of day one of the regime will not count as a breach of conditions, as it would under current regulations. That will make the relaxation on listing more effective for potential entrants to the regime.
The final change allows extensions to the Real Estate Investment Trusts (Joint Ventures) Regulations 2006 to be effective from 1 January. A copy of the draft joint venture group regulations has been made available. The revised regulations extend the rules for single-company joint ventures to cover joint ventures carried on by groups. Again, following consultation, we propose a further relaxation to the draft regulations. That is to allow companies 60 days after the regulations come into force to give joint venture notices for accounting periods beginning on or after 1 January 2007. The relaxation will allow companies to wait until the regulations come into force before giving a joint venture notice, and will still enable them to take advantage of the retrospection offered by paragraph 14 of the schedule.
The hon. Member for Rayleigh asked whether we were minded to change the qualification rule that there should be a full listing, rather than an AIM listing, to the stock exchange. He repeated my commitment of last year to keep the matter under review, although I did not announce on Report a formal review. Since then, I have actively championed—in the UK and in other parts of the world—the benefits of the AIM regime and its lighter regulatory approach.
As the hon. Gentleman knows, we judged last year that it was important, particularly when the REITs regime was becoming established, that investors could have confidence that they would have the regulatory protection of a full stock exchange listing, especially given that we were trying to encourage retail investors to see the attractions of such collective investments. Our judgment on that matter has not changed; we have not decided to change the AIM requirement, but I am happy to say to him that I will continue to keep the matter under review. Furthermore, at the time of the pre-Budget report, we will set out in detail our thinking on the matter, following nine months’ operation of the regime. It is too early at this stage, however, to reach a judgment different from that of a year ago.

Mark Francois: I thank the Minister for that comprehensive answer. We look forward to hearing what he comes up with in the 2007 pre-Budget report. In connection with that, I shall briefly offer him the thought that allowing REITs to list on the AIM would be a good way of boosting residential REITs, because residential property companies often have a much smaller market capitalisation, as many are not listed on the full London stock exchange. Perhaps he will bear that in mind ahead of the pre-Budget report.

Edward Balls: I understand the hon. Gentleman’s point. A year ago, we discussed in detail our judgment that that was not the right road to go down at this stage, but I am happy to set out more fully our thinking in the light of 9 months’ operation of the REITs regime. It is too early to reach a different judgment at this stage.
The hon. Gentleman also asked about residential REITs, and I did not seek to fudge the answer. There are no residential REITs; there are 14 REITs, of which two have a residential element but are not fully residential. In the past year, we have consulted widely with the residential sector. Indeed, at the instigation of the right hon. Member for North-West Hampshire (Sir George Young), who took a particular interest in such matters, I met him following our consideration of what became the Finance Act 2006. I then met a group of experts, whom he had put in touch with Treasury officials, to discuss the issues. We have not been inactive on that score.
The nature of the residential and rental markets in the past year has complicated potential residential REITs. We said—it was debated fully—that it was more complex for residential REITs and registered social landlords to take such a step and that it was therefore no surprise to us that the lead came from the commercial sector. Proposals involving wider tax changes, which go beyond the residential REITs regime, have been put to us and we are studying them. If there are barriers to the operation of residential REITs that we can deal with, we will do so. The regime is not set in stone, but at the same time, we set out clearly our objective of a revenue-neutral shift to a REITs regime. Issues on the tax side were proposed to us which, to say the least, would have required close and careful attention before we made any decision to move forward.
It is worth noting that Lend Lease has been public about the potential for floating a residential REIT around their development in the Olympic area and we are watching that with interest. However, at this stage a residential REIT has not come forward, although after only five months it is not possible to conclude that none will do so. As I said, if we can, we will address the relevant issues and we continue to keep a close eye on developments in the residential sector.

Rob Marris: I am heartened by my hon. Friend’s comments, particularly what he said on the wider changes being proposed to him and his colleagues in respect of residential REITs. I still have a fear, which I expressed in the Committee last year, that if residential REITs simply buy up existing property, it could lead to an increase in house prices, which are already overblown. Most people are keen that there should be much more house building in the United Kingdom and I hope that REITs will have a role to play in that respect. Paragraph 3.121 on page 69 of the Red Book refers to a
“target to raise the number of new houses being built to at least 200,000 net additions a year by 2016. Substantial progress towards this target is being made with over 180,000 net additions in the year to March 2006.”
I make two comments on that paragraph. It ties into the residential aspect of the REITs regime if we can encourage new house building, but 200,000 net additions a year in housing stock in the UK is woefully inadequate. There are approximately 150,000 divorces each year and probably almost as many partners who are not married who break up, many of whom have children, and that is likely to lead to the formation of many more households. There is also considerable migration into the United Kingdom, which has brought much benefit to the economy but put pressure on the housing stock.
The figures that have been published since the Red Book itself was published show that housing starts in the United Kingdom fell in the year to March 2007. They went below 180,000 by several thousand; we actually went in the wrong direction in that financial year. The Government must consider whether the REIT regime could be used or whether the wider tax changes referred to by my hon. Friend are needed markedly to increase the number of houses and flats—residential units, if I may put it that way—being built in the United Kingdom each year. The figure in France, which has a similar population, is 300,000 units a year and it still has markedly increasing house prices, although not to the same extent as in the United Kingdom in recent years. It causes great social pressure in our country and great distress to people who cannot afford to buy a house because supply is too limited, meaning that prices go up very considerably.
I am not a housing expert, but I believe we need to build more than 300,000 units a year and the market is not doing that. There is clear market failure in that regard, perhaps occasioned by land companies holding on to their land banks and not developing them. I urge the Treasury to consider the wider issue of what tax changes could be brought about, perhaps by means of penalties for those sitting on land banks, tax encouragement for those who wish to create new housing stock, or a combination of the two. That may or may not fit into the residential aspect of the REITs regime. In terms of the AIM issue, which might suit residential REITs better, I understand why my hon. Friend is keeping the matter under review, as REITs have been in operation only since January. The Treasury and the Government need to look at the tax regime to encourage a step change upwards in the number of housing units being built in the United Kingdom each year.

Edward Balls: I take my hon. Friend’s comments very seriously. We had a long discussion last year about the way in which the REITs regime could contribute to our wider objectives on housing supply. I explained then that the real issue was whether we could reach a consensus in the country about building more houses, but that consensus is proving elusive.
I owe the hon. Member for Dundee, East an apology. To answer his question, the calendar year was specified so that the regulations could apply from the start of the UK REIT regime on 1 January. We will, as I said, keep the AIM issue under review in the coming months as well as any changes that are proposed or considered to encourage residential REITs.

Question put and agreed to.

Schedule 17, as amended, agreed to.

Clause 52

Alternative finance investment bond

Edward Balls: I beg to move amendment No. 84, in clause 52, page 33, line 32, leave out sub-paragraph (ii) and insert—
‘(ii) to make a repayment of the capital (“the redemption payment”) to the bond-holder during or at the end of the bond-term (whether or not in instalments),’.

Eric Illsley: With this it will be convenient to discuss Government amendment No. 85.

Edward Balls: The clause introduces tax rules on a type of Islamic bond known as a sukuk. In the Finance Acts of 2005 and 2006, we introduced legislation that set out the tax treatment of several sharia-compliant financial products, on which interest is not paid, but an alternative financial return is paid instead. The broad principle of the tax rules is that when a return paid to or by a saver or borrower is economically equivalent to interest, it is taxed as though it were interest.
Those measures were part of our wider agenda to make the City of London a global, wholesale financial centre for Islamic financial products and to ensure that the Muslim community in our country has the widest possible access to Islamic retail financial products. In pursuing our agenda to take forward those twin, complementary objectives, we have established a standing committee of Islamic finance experts, the first meeting of which I chaired a few weeks ago.
At the meeting, there was acclaim around the table for the consensual steps forward that we have taken in this House in previous Finance Acts. I am sure that the signal that the UK is changing its tax law in the whole Islamic finance area to encourage the commercial issuing of sukuk has been widely welcomed around the world. Our subsequent announcement that we are considering a Government bond issue that is consistent with sukuk principles has also been widely welcomed. That sends out a powerful signal.
The amendments make small but important technical changes, and were drafted as a result of the consultation. Although sukuk are economically similar to debt securities in law, they are not debts or loans, which gives rise to difficulties with applying the tax rules that normally apply to debts and loans. The interaction of the rules in the clause with certain tax rules was not fully appreciated when the Bill was published, and the amendments deal with some of those interactions. I am happy to answer more detailed questions on the amendments, which ensure that the Bill will achieve our announced intentions.

Theresa Villiers: I have a few remarks to make that embrace both the amendments and the clause, which I welcome. They are intended to enable UK-based companies to issue sharia-compliant bonds, which are commonly known as sukuk. I welcome also the greater clarity that the measures will bring to the tax treatment of people who invest in sukuk, whether they are issued by UK or foreign companies.
During Committee debates on clauses 95 and 96 of last year’s Finance Bill, on wakala and musharaka finance, I recall drawing the Committee’s attention to a range of other sharia-compliant financial products, including sukuk. Indeed, I believe that that was the sole reference to the word “sukuk” in the whole of Hansard until this afternoon, although I must acknowledge that I made an error by referring to the plural of sukuk as sukuks, which is incorrect.
I pointed out last year the growing importance of sukuk issuance, and I am therefore very pleased to see that the Government have subsequently chosen to legislate to make it easier for the City of London and UK-based operators to obtain a share of that increasingly important market. On many occasions during this year’s and last year’s Finance Bill proceedings, I have had harsh things to say about the Government and their failure to respond to people’s concerns, but I must say that I have had extremely positive feedback about the Government’s efforts on that issue and on the meeting to which the Economic Secretary referred. The amendments under consideration today are a direct result of the discussions at that meeting, which is why they are welcome.
I have only one qualification. There is in one way in which the proposals have disappointed. The new rules should assist people seeking to securitise Islamic mortgage portfolios using a sukuk, and the focus on mortgages is demonstrated by subsection (3)(b). It expands the definition of “financial institution” in section 46 of the Finance Act 2005, but only in relation to bond assets that fall within sections 47 and 47A, which include the tax provisions that govern the two main structures used by banks to provide Islamic mortgages.
I have received representations that the clause’s focus on mortgage securitisation limits its scope. The Treasury seems to view sukuk as the Islamic equivalent of securitisation, rather than the equivalent of corporate bonds in general. It is worth considering, perhaps for next year’s Finance Bill, ways of broadening the scope of the provisions to make them more usable for all companies that wish to raise long-term finance using sukuk. It may be worth consulting further on that point.
I appreciate that the measure represents a new area and that we are in relatively uncharted territory, so we must take care to ensure that changes that are meant to facilitate sharia-compliant financial products neither cause unintended consequences nor produce tax loopholes. However, if the Government are genuinely enthusiastic about making London an attractive destination for Islamic finance—and I believe that they are—it is worth taking time to determine whether it is possible to broaden the clause without causing any negative consequences.
I welcome the Economic Secretary’s announcement about considering whether the Government should issue debt that is structured as a sukuk. There is in the idea an interesting potential for gaining access to a wider range of investors, and it would be useful to hear what progress is being made with it. Some of the state governments in Germany have issued sharia-compliant bonds, so there is a precedent for it. It will be interesting to see what the progress the Government have made.
Finally, I recall again my speech last year on the issue, when I mentioned not only sukuk but a range of Islamic financial products, including ijara leasing transactions, ijara-wa-iqtina, which replicates hire purchase, takaful insurance products and Islamic risk-mitigating instruments. Just as the Government responded to my comments last year about sukuk, I hope that they might look into whether the tax structure might be adapted to facilitate other sharia-compliant products, not only for the reasons of allowing the City to take a significant share of the market, but for the reasons to which the Economic Secretary has referred regarding the importance of ensuring that financial inclusion is extended to all sectors of our community, including those of the Muslim faith.

Edward Balls: The issue to which the hon. Lady refers was also raised at out Islamic finance working group. The initial reaction of Islamic finance experts in the Treasury was that the proposal risks opening up substantial tax-avoidance difficulties for us. One issue that the group will consider in the coming months is precisely the issue that she raises, so that if we could sensibly widen the scope without causing difficulties, we would.
On the wider issue raised by the hon. Lady, I am pleased about the consensual and cross-party nature of discussions about these matters, at least within Treasury-brief circles, and I shall continue to work closely with all Members of the House to take the agenda forward.

Amendment agreed to.

Amendment made: No. 85, in clause 52, page 35, line 50, at end insert—
‘(7) For the purposes of section 417 of ICTA (close companies)—
(a) a bond-holder is a loan creditor in respect of the bond-issuer;
(b) arrangements falling within section 48A shall be disregarded in the application of section 417(1)(d).
(8) For the purposes of Schedule 18 to ICTA (group relief)—
(a) a bond-holder is a loan creditor in respect of the bond-issuer;
(b) paragraph 1(5)(b) shall be disregarded in determining whether a person is an equity holder by virtue of arrangements falling within section 48A.”’.—[Ed Balls.]

Clause 52, as amended, ordered to stand part of the Bill.

Clause 53 ordered to stand part of the Bill.

Clause 54

Trust income

Question proposed, That the clause stand part of the Bill.

Theresa Villiers: The clause provides a welcome correction for some errors contained in the trust modernisation legislation that we had the pleasure to consider in last year’s Finance Bill. I confess that the error escaped my research in preparation for the scrutiny of that Bill, although I recall that there was still a lengthy list of problems on which we sought clarification.
The clause appears to achieve the intended outcome. It will restore the mechanism that was in operation prior to the 2006 Act by which trustees of a settlement who receive a payment made by a company on the purchase of its own shares are taxable only on the excess over the original subscription payment for the shares. The drafting error in the 2006 Act would have meant that they were taxed on the entire payment.
Like me, the Chartered Institute of Taxation welcomes the clause, but it has expressed serious concerns on two points. First, it expresses regret that the period for consultation was short. It pointed the problem out on 3 August 2006, which should have given the Government a period for consultation. Secondly, the CIOT highlights a more significant problem with the approach taken to implementation, stating that
“we reiterate our concern at how HMRC intend to implement aspects of these changes, given that the Notes and Tax Calculations for the 2006/07 Return are inaccurate.”
It goes on to state:
“It is most unsatisfactory that Returns for 2006/07 submitted before Royal Assent is given should be filed on the basis that the whole amount of payment received on a buy-back of a company’s shares is taxable, with a correction having to be made subsequently.
It is disappointing that our comments on improving the clarity of Explanatory Notes to the legislation have been ignored.”
I have some sympathy with the CIOT’s point of view. It does not seem to make a great deal of sense to require that tax returns submitted before Royal Assent have to comply with the existing and incorrect legislation. The CIOT states that that
“is a recipe for muddle and confusion”
that is
“accentuated by numerous piecemeal changes to the trust taxation regime over the past few years”.
Bearing in mind that the provision will be backdated when the clause is enacted, it seems pointless to require people to submit returns that will have to be corrected. It also seems unfair to require people to include in their tax return a sum of money—the excess over the subscription price paid for the shares—that HMRC knows will not be taxable once the Bill comes into effect. The CIOT concludes:
“The taxpayer should not be penalised through enactment of defective legislation”.
If HMRC will not accept returns submitted on the basis of the legislation as corrected by clause 54, the notes to the 2006-07 return should at least be amended to alert taxpayers of the need to delay filing.
In conclusion, I should like to put on record a general comment about the provisions in the 2006 Act on the income and capital gains tax treatment of trusts, which the clause seeks to amend. The provisions were billed as simplifications and modernisations, but this is one of the most mind-boggling, opaque and complex structures it has ever been my misfortune to read about—and that is even before one gets into the twists and turns of the changes to the inheritance tax regime that caused such controversy in relation to schedule 20. I suspect that the Economic Secretary may return to this Committee in future years with further corrections to this problematic legislation.

Edward Balls: I hope that the next time the Minister responsible returns to this piece of legislation, we will be celebrating the return of the Paymaster General, who is far more of an expert on these matters than myself.
The clause amends a minor omission in last year’s trust modernisation legislation concerning payments received by trustees, as the hon. Member for Chipping Barnet said. The omission in the Finance Act 2006 meant that in a buy-back the whole payment is taxed. The clause corrects the position so that only the whole payment, less the original subscription price, is taxable. Because the legislation that we are correcting came into force on 6 April 2006, we are backdating the clause to take effect from that date to ensure that nobody loses out. HMRC consulted on the draft legislation, and representative bodies said to us that they were content. A further minor omission in the same legislation has been identified and is corrected by clause 55.
The omission is regrettable but neither HMRC nor the representative bodies, nor any other interested parties, picked it up during the passage of last year’s Finance Bill. A small number of trusts will be affected. Each year, an estimated 20 trusts, out of some 200,000 trusts that make a return, will receive a payment from a company’s purchase of its own shares. The return for 2006-07 had to be finalised by HMRC last summer before it was aware of the omission. However, the return is based on how the legislation was always intended to work, and is rectified by the clause.
HMRC issued guidance advising trustees affected by the omission to wait until the Finance Bill received Royal Assent before making their return. For the small number of cases that are likely to be affected by the clause, return guidance will lead trustees to enter an amount in accordance with the legislation as was always intended. Therefore, taxpayers who are not aware of the omission will not be disadvantaged. The consultation did not last as long as we would have liked, but we are satisfied that we consulted properly and, as a result, we have addressed the omission that the hon. Lady identified.

Theresa Villiers: The Economic Secretary makes a reassuring point that the HMRC is trying to get the information out to ensure that the trusts affected know that they should not make their return before Royal Assent. However, those who do not receive, or are not aware of, the information will still be required to submit a return based on incorrect legislation. Is that correct? I just wanted to check that I have understood correctly.

Edward Balls: I think I said that we will ensure that the guidance for the 20 or so trusts operates so that people do not lose out as a result of the process of correcting the omission. I do not know whether we know the 20 trusts, but if we do that would mean fewer letters to write than those sent to Committee members. We ought at least to be able to manage 20.

Question put and agreed to.

Clause 54 ordered to stand part of the Bill.

Clause 55

Trust gains on contracts for life insurance

Question proposed, That the clause stand part of the Bill.

Theresa Villiers: I should just like to emphasise that the same point that I made in relation to the previous clause applies in respect of this clause, which again makes a correction and, again, the CIOT is concerned that the Revenue is expecting people to submit tax returns based on an incorrect assumption. The CIOT goes as far as saying:
“It is deplorable that HMRC are...purporting to deny a tax benefit in direct contradiction to the relevant legislation.”
The Treasury has admitted its error. It is unfair to penalise the taxpayer for a mistake that was made by Ministers. I hope that, in this case, too, the Economic Secretary and his officials will make the greatest efforts to ensure that those affected by this correction are well aware of the need to postpone submitting a return until after Royal Assent.

Edward Balls: I understand that although the clause corrects the position, unlike the previous clause it corrects it even though the position was in favour of trusts, rather than against them. In any case, the hon. Lady made the same point as previously, so I am very happy to make the same point as previously, too.

Clause 55 ordered to stand part of the Bill.

Clause 56

Offshore funds

Edward Balls: I beg to move amendment No. 116, in clause 56, page 38, line 33, at end insert—
‘(4) But the reference to offshore funds in section 760(3)(a) does not include any arrangements which are not a collective investment scheme for the purposes of that Part of that Act.”.’.

Eric Illsley: With this it will be convenient to discuss Government amendment No. 117.

Edward Balls: The clause amends the rules of the offshore funds tax regime, both to enable offshore funds to use popular commercial structures that allow investors access to a range of financial instruments through a single product and to ensure that the offshore fund regime continues to provide a level playing field for onshore funds.
The offshore fund rules were introduced in 1984 to deter avoidance schemes that sought to roll off investment returns free of UK income tax by holding investments offshore. The regime aims to put UK investors investing in offshore funds on a similar footing in respect of tax for UK investors in UK funds. The sector is fast moving and aspects of the regime have begun to act as a barrier to commercial developments. That is why we announced in October that the Government would consult with a view to reforming the regime in next year’s Finance Bill and why we are making the changes in clause 56 while that consultation continues.
Industry highlighted the fact that one of the changes in the clause would retrospectively affect UK investors in funds that fall within the scope of the clause, as well as compliant funds investing in such funds. Our two amendments will ensure that the legislation will not retrospectively affect any investor and that funds investing in other offshore funds or which for commercial purposes hold underlying assets through intermediate holding companies, including funder fund structures, will not be affected by the changes. The offshore regime relies on the definition in the Financial Services and Markets Act 2000. I commend the amendment to the Committee.

Amendment agreed to.

Amendment made: No. 117, in clause 56, page 39, line 5, leave out subsection (7).—[Ed Balls.]

Clause 56, as amended, ordered to stand part of the Bill.

Clause 57

Election out of special film rules for film production companies

Question proposed, That the clause stand part of the Bill.

Theresa Villiers: The clause allows television companies that do not qualify for film tax credit to opt out of the new tax regime for film companies. I am delighted to see that provision in the Bill, because I asked the Government to include it during the debate on the Finance Bill last year. In scrutinising last year’s Bill, it seemed unfair to inflict a controversial new tax framework and a significant compliance burden on companies producing TV and films that were not destined for general release, and which therefore could not qualify for the film tax credit.
I therefore tabled an amendment to remove from the new accounting regime those companies that could not qualify for the tax credit, such as TV companies. The response of the Economic Secretary on that occasion, as recorded at column 234 of the Hansard report of Standing Committee A for 18 May 2006, was to dismiss my amendment as going “completely against the intention” of the Bill. Although I am pleased that he has seen the light and responded to my concerns, I have to ask why the Government could not get the issue right the first time around. The explanatory notes refer to discussions with the industry, which no doubt were useful, but the problem was flagged up with the Government in Committee last year, while they still had time to solve it in that Bill.
That is a recurring theme in the history of the Chancellor’s film tax legislation. Since he first introduced his film tax break in 1997, the rules have been revised by Finance Acts in 2000, 2002, 2004, 2005 and 2006, and now they being revised again in 2007. When I highlighted that unfortunate history in the debate on last year’s Finance Bill, the Paymaster General and the Economic Secretary dismissed my concerns. They were entirely confident that they had got film tax completely right, even though they had got it wrong so many times in the past. Their confidence has proven to be sadly misplaced, because here we are again, although this is not the first time that the House has been asked to consider film tax since the previous Finance Bill. It is regrettable that after five major changes to the film tax regime in seven years, the Government have had to come before the House twice in the past 12 months to ask for approval of its cultural test for its film tax regime.
I asked the Economic Secretary last year whether he anticipated any problems obtaining European Commission approval for the new film tax credit. In his confident response, he said:
“The hon. Lady suggested that the approach to defining UK expenditure in clause 35 was in some way determined by the European Commission. There was absolutely no truth in her statement. On the contrary, the definition of UK expenditure reflects our policy aim of encouraging producers to make full use of film-making skills, facilities and infrastructure in the UK.
It is true that, as is required, we have been discussing with the Commission the securing of state aids approval for the new relief, but the Commission has not indicated any concerns about how we define UK expenditure nor requested that we change the definition in any way. We have, for example, reduced the qualifying limit from 40 per cent. to 25 per cent., and we made that decision on the basis of the points put to us during the consultation. In our view, the definition is well within the ambit and requirements of the state aids rules. We are confident that those discussions will proceed apace.”
The Economic Secretary goes on to say a little later that
“productions for which filming has taken place predominantly or wholly overseas will be entitled to a level of benefit lower than that of productions filmed in the UK. That is entirely in line with the Government’s policy aim, set out clearly in the legislation, of encouraging filmmakers to make full use of facilities and infrastructure in the UK. This is an enhanced tax relief for making British films in Britain, so it is not our intention to spoil overseas film industries.” —[Official Report, Standing Committee A, 18 May 2006; c. 232.]
However, that was exactly what the Commission later told the British Government that it could not do. It required the deletion of that element of the Economic Secretary’s cultural test that gave favoured status to films made in Britain. The only permissible criterion was whether or not a film was culturally British.
Therefore, despite the brave words of the Economic Secretary, the Commission would indeed determine the approach taken to “UK expenditure” in relation to the film tax credit. Hence, the Paymaster General was forced to return to the House to ask for its approval of a second revised cultural test instead of the one debated in Committee last year. That had a highly destabilising impact on a number of UK films which thought that they were going to qualify for the new tax credit, but then found that they could not. It also delayed the implementation of the new film tax rules and forced the Government into a temporary extension of the reliefs outlined in sections 42 and 48 to plug the gap. Those were the reliefs that the Economic Secretary had repeatedly told the Committee last year were flawed.
To compound that chapter of accidents, no sooner had the Treasury announced the temporary extension of the sections 42 and 48 reliefs, then it announced out of the blue that it was going to scrap sideways loss relief in relation to those reliefs, thereby undermining their value. It was reported that more than 100 films would be negatively affected, including “Casino Royale”. The film industry lobby swung into action. Three days later, it forced one of the swiftest U-turns in Government history. It was frankly astounding that the Government announced a significant crackdown on sections 42 and 48 reliefs, which they had just agreed to extend and which HMRC was actively encouraging filmmakers affected by the debacle over the cultural test to use.
Frankly this is a shambles. The Government’s incompetent handling of film taxes has cost the taxpayer billions and caused significant instability for film financing. I very much hope that the Economic Secretary does not have to return yet again to this Committee next year to ask for further changes to the film tax regime.

Edward Balls: Clause 57 allows companies to opt out of the special rules for film production companies, for which we legislated in the Finance Act 2006. The clause is designed to respond to representations from the TV industry in particular and has been welcomed by it. The laws introduced last year were discussed with a number of TV production companies and tax professionals. We believed then, and still believe, that they make sense for many companies. Therefore, we want to leave them in place. As the hon. Lady said, the point was made in Committee last year that concerns had been raised. Rather than rushing to make sudden changes then without consultation at a later stage in last year’s Finance Bill, we had further discussion with those who saw problems and proposed a simple proportionate solution, which is the clause before us today.
As for the European matter that she raises, the EC treaty prohibits subsidies that distort competition and trade. Aid is allowed on cultural grounds for films. The Commission has set out criteria for that. The UK’s cultural test was notified in December 2005. The Commission considered the test last September and raised concerns that it was too focused on economic rather than cultural factors. The Treasury, with the Revenue and the Department for Culture, Media and Sport, then worked to produce a revised test that met those concerns, while still supporting the development of a sustainable film industry. We made those changes to ensure that, consistent with our European obligations, we would transit to the new regime, which is operational.
In recent years, we have had to make changes to the film regime to ensure that tax avoidance was addressed. Last year’s regime, which we debated at length, is a simplified, sensible and effective regime. The fact that we have such a small change before us today is a tribute to the success of that new regime, and I commend the clause to the Committee.

Clause 57 ordered to stand part of the Bill.

Further consideration adjourned.—[Kevin Brennan.]

Adjourned accordingly at twenty-nine minutes to Eight o’clock till Thursday 24 May at Nine o’clock.